For Lending

Banks that issue credit cards are watching their default rates go through the roof and that’s really bad news considering a proposed change in the Financial Accounting Standard. The new rule could force the banks to increase their cash reserves to cover bad loans leaving less money available for loans to small business and consumers.

So what does that mean for the consumer?

First of all, if you are behind on your credit card payments and you can’t see a way to catch up, now is an excellent time to call your card company and negotiate a cash settlement. It’s probably a good idea to use a non-profit credit counseling service to assist you in coming up with a proposal that is reasonable and a plan for how to pay it.

Because of a change in the FAS, banks will be required to bring “off the book loans” and put them “on the books”. It has been a common practice for banks to bundle credit card loans into an investment vehicle and sell them to the market. These loans, because they are investment vehicles, did not have to be shown on the bank’s balance sheet.

Bank regulations require that a cash reserve be kept to cover bad debt on loans. However, since the off the books investment packages are not included on the bank’s balance sheet, there is no requirement to keep a cash reserve for them.

The accounting change will require that off the books loans be placed on the balance sheet and be subject to the requirements of any other loan. What this means is banks will need to greatly increase their cash reserves. To give an idea of how big an impact this will have; American Express says it will have to add $28 billion to its loan balance, Discover $20 billion and Citigroup, a bailout recipient, has to add $98 billion.

That huge influx of new loan liability will require that billions of dollars will have to be set aside as reserves. The fact that at least 10% of those loans are bad has motivated the banks to clean them up as fast as they can. If they can get $600 on a $1000 balance, that means they have just saved on the amount of reserve required for a $1000 loan. Banks are so motivated to reduce the number of delinquent debt that they are actually calling consumers themselves, not using collection agencies, and offering settlements.

There really is no downside for the consumer. By being late on the payments, the consumer’s credit rating is already damaged. If the cash can be put together the consumer can get a significant discount on their debt. However, the time to act is now. Late fees and a default interest rate of 30% are still being applied so why wait.