Credit card debt relief

I am pleased to appear before this subcommittee today to discuss trends in consumer lending and the Federal Reserve Board's view of how recent developments in this sector are affecting U.S. commercial banks. As the subcommittee knows, consumer delinquencies on nonmortgage debt have increased in recent periods and are beginning to affect profit margins at some financial institutions. The Federal Reserve has been monitoring these conditions and discussing their implications with individual banking organizations and industry groups. However, given the generally strong financial condition of the institutions most affected by these developments and that of the U.S. banking system, we believe that these adverse trends do not currently present a material threat either to individual banking organizations or to the overall banking system.

In my remarks, I would like to begin with an overview of the economic developments that have caused the Federal Reserve to devote greater attention to consumer lending matters. I shall then turn to the emerging - and still well-contained - consequences that these developments are having on the banking organizations that are most affected and on the industry overall. Because current concerns are predominantly centered on revolving credit portfolios, I shall focus my comments on a discussion of credit card lending activities. Finally, I shall discuss the steps taken by the Federal Reserve throughout the past year to caution its examiners, state member banks, and bank holding companies about the risks inherent in weakening credit standards and to ensure that financial institutions are taking appropriate action to address emerging problems in consumer loan portfolios.

ECONOMIC TRENDS

Economic conditions in the United States have in recent years been favorable to growth in spending and borrowing by the household sector and to strong growth in consumer lending by US. banks. Just since early 1992, nonfarm payroll employment has increased nearly 11 1/2 million, driving the U.S. unemployment rate to 5.3 percent in June of this year, its lowest level in six years. As one consequence, personal income has risen substantially. The dramatic rise in stock and bond prices in recent years has also produced sharp gains in wealth for some households.

During this same time period, rates and fees on consumer financing products have been coming down. Average credit card rates, which stood at about 18 1/4 percent in late 1991, declined to less than 15 1/2 percent by May of this year. At the same time, annual fees on credit cards were dropped by many institutions. In addition, declining residential mortgage rates throughout most of this interval contributed to a significant reduction in monthly payments on such debts. While mortgage rates have recently backed up, the relatively low mortgage rates of the early 1990s precipitated a refinancing boom that allowed many consumers to significantly reduce their monthly mortgage obligations.

Combined, these generally favorable developments have given consumers the confidence and financial foundation to incur additional debt to finance major purchases. Nevertheless, some concerns remain about the increase in consumer debt. Aggregate statistics do not address conditions in individual households, an important consideration because the economic expansion has not affected all households equally. Further, while for some households the use of credit in making a purchase is simply a matter of convenience or a means of managing liquidity, for others borrowing may be a means of sustaining consumption through a period of household economic distress.

Nonmortgage consumer debt has grown at double-digit rates over the past two to three years. This rapid pace is not unusual for a period of economic expansion. Indeed, as the economy emerged from recession in 1991, growth in nonmortgage consumer debt was much slower than typical, reflecting sluggish spending on durable goods and lingering fears about long-term layoffs and other threats to job security. However, by 1994 consumer confidence had recovered considerably, and demand for autos and other durable goods had strengthened. Nonmortgage consumer debt grew about 15 percent that year and the next, but even this rapid pace remained below that of a decade earlier. Lower inflation in recent years can account for some of the difference.

Recently, revolving credit - primarily credit card debt - has been, by far, the fastest growing component of consumer debt, averaging annual increases of 20 percent over the past two years. However, that performance - rapid growth during an expansion - is also typical of the past two decades. The cumulative effect has been a dramatic rise in the relative importance of revolving credit. In 1977 when first reported separately to the Federal Reserve, revolving debt of U.S. consumers totaled $30 billion, or 14 percent of all consumer debt. In May of this year, the amount outstanding was $444 billion, or nearly 40 percent of the total. Surveys show that 80 percent of U.S. households now have at least one credit card.

A consequence of the increase in consumer borrowing of recent years is that debt-servicing requirements - that is, the amount of scheduled payments of principal and Interest - have consumed a bigger share of disposable income. Our staff estimates that this ratio, which includes both mortgage and nonmortgage payments, peaked in late 1989 at about 17 1/2 percent and then declined over the next four years to about 15 1/2 percent in 1993, as households curtailed their borrowing and average interest rates on their debts fell. Since then, the ratio has risen to about 16 3/4 percent. This standard measure is based on aggregates that include households without debt and uses estimates of scheduled payments. The Survey of Consumer Finances, conducted periodically by the Federal Reserve, suggests that the median ratio of actual debt payments to pretax income of debt-holders was relatively constant from 1989 to 1995, as was the proportion of the debt-holders that had very high debt repayment to income ratios. What has tended to rise over time is the proportion of low-income households with an unusually high fraction of their income absorbed by debt repayments. Unfortunately, the latest data - which are still preliminary - are a year old.

To be sure, some of the increase in consumer debt is merely a reflection of the greater prevalence of convenience use of credit cards as a substitute for cash or check payment, with card balances paid in full each month. This trend has been reinforced in recent years by a variety of incentives, such as the availability of frequent flier miles. But - as our Survey of Consumer Finances suggests - there are also signs that some households have let their debts build up to the point where they may have difficulty servicing them. Loan delinquency rates and personal bankruptcies are both up.

Generally speaking, delinquency rates on nonmortgage consumer loans have been trending up for the past year, with some of the increase in delinquency rates merely the result of the "seasoning" of recently underwritten loans, a typical pattern. However, for credit cards, the widely followed statistics of the American Bankers Association show that the delinquency rate by number of accounts is historically high. The more comprehensive figures from the official bank Call Reports based on the dollar volumes of loan balances, however, show a much milder upturn in delinquencies - but still one warranting our attention.

CREDIT CARD LENDING BY COMMERCIAL

BANKS

These economic and market developments have had clear effects on banks. As a percentage of total bank loans, consumer debt (including mortgages) has been increasing steadily for some time - from 33 percent of total bank loans in 1980 to roughly 40 percent five years ago and about 44 percent today. This shift in asset allocation by banks reflects several factors, not the least of which is a declining market share of the credit extended to commercial customers. In part, it also reflects substantial growth in credit card debt. Since late 1991,credit card debt has risen about twice as fast as total loans. If one adds back estimates of the outstanding securitized credit card debt of banks, such credit has risen almost three times as fast as total loans at banks.

The industry's total increase in credit card loans has come about with the growing popularity of cards, supported by their aggressive marketing by some banks. Marketing campaigns typically involve broad-based, regional, or nationwide solicitations and often include pre-approved lines of credit based on the results of "credit scoring" models that statistically evaluate an individual's credit worthiness. In additions, banks' success in securitizing consumer debt instruments for resale in capital markets has increased both their willingness and their ability to make such loans.