Operational Problems in Offering Credit Cards

Banks and other companies offering credit cards must solve several significant operational problems. First, the break-even point in card operations appears to be relatively high, placing pressure on credit card companies to sign up enough merchants to accept the cards and enough individuals to use them. The two problems are, of course, interrelated. Merchants are willing to accept a card only if they believe there will be sufficient customers using it to make the program worthwhile. Similarly, individuals are willing to make use of their cards only if a large number of merchants will accept them in payment for goods and services. One problem that has plagued credit-card operations for many years is losses due to customer fraud. Recent estimates by the Federal Reserve System find that fraud losses represent 15 to 20 percent of total card charge-offs for most plans.
During the late 1960s some U.S. banks tried to overcome the card-acceptance barrier by mass mailing of unsolicited cards, resulting in large-scale credit and fraud losses. Fearing that the safety and soundness of the banking system might be jeopardized and public confidence in banks shaken, Congress Passed the Consumer Credit Protection act, which prohibits unsolicited mailing of credit cards. Moreover, once the card-issuing company has been notified, the customer is no longer liable for any unauthorized use of his or her card. Prior to notification, the cardholder can only be held responsible for a maximum of $50 in unauthorized charges per card. Moreover, the customer cannot be held liable for unauthorized use of his or her credit card if the card was not requested or used, if it carries a means of identifying the authorized user (such as a signature or photograph), or if the customer was not notified of the $50 maximum liability. In addition, card issuers must provide the customer with a means of notifying them in case of card loss or theft.
Federal legislation has done much to enhance public acceptance of credit cards. Most cards are issued to customers today only after a careful analysis of their credit standing. That is why cardholders frequently are able to use their cards as a credit reference to aid in the cashing of checks or to obtain other forms of credit. Most merchants know that charge-card holders tend to have higher incomes and better payment record than the general population.
The most profitable credit-card accounts from the point of view of the issuing companies are those with high balances which are not paid off immediately (I.e., those held by installment users). However, less than half the sales volume experienced by most card programs winds up as carry-over balances subject to finance charges. Most card users are convenience users, who pay off their credit purchases within the normal billing cycle. Banks have found that they cannot make significant profits on their credit card operations when over half their cardholders are only convenience users. Moreover, cards users with the highest incomes and best repayment records typically economize on their cash balances and delay payment as long as possible, which further reduces the earnings from card operations. However, the performance of credit-card programs does improve with experience. Card companies become more skillful at identifying profitable groups of customers and at minimizing fraud and bad-debt losses. In addition, credit card programs bring in customers who may purchase other financial services from the same institution, such as installment loans and savings plans.

The determinants of consumer borrowing

Consumers represent one of the largest groups of borrowers in the financial system. Yet individual consumers differ widely in their use of credit and their attitudes toward borrowing money. What factors appear to influence the volume of borrowing carried out by households? Gross income is a common standard in this instance. For younger borrowers, without substantial assets to serve as collect for a loan, a cosigner may be sought whose assets and financial standing represent more adequate security. The duration of employment of the borrower is often a cortical factor, and many institutions will deny a loan request if the customer has been employed at his or her present job for less than a year.
The past payment record of a customer usually is the key indicator of character and the likelihood that the loan will be repaid in timely fashion. Many lenders refuse to make loans to those consumers who evidence "pyramiding of debt"-that is, borrowing from one financial institution to pay another. Evidence of sloppy money handling, such as unusually large balances carried on charge accounts or a heavy burden of installment payments, is regarded as a negative factor in the loan decision. Loan officers are particularly alert to evidence of a lack of credit integrity as reflected in frequent late payments or actual default on past loans. The character of the borrower is the single-most-important issue in the decision to grant or deny a consumer loan. Regardless of the strength of the borrower's financial position, if the customer lacks the willingness to repay his or her debt, then the lender has made a bad loan.
Most lenders feel that those who own valuable property such as land, buildings, or marketable securities are more reliable than those who do not own such property, especially if the property itself is pledged to secure the loan. For example, homeowners are usually considered to be better risks than those who rent. Moreover, borrowers´ chances of getting a loan usually are better if they do other business (such as maintain a deposit) with the lending institution. If more than one member of the family works, this is often viewed as a more-favorable factor than if the family depends upon one breadwinner who may become ill, die, or simply lose his or her job. Having a telephone at home is another positive factor in evaluating a loan application, since the telephone gives the lender an inexpensive way to contact the borrower. One way to lower the cost of a loan is for the consumer to pledge a bank deposit, marketable securities, or other liquid assets behind the loan. The disadvantage here is that such a pledge "ties up" the asset pledged as security until the loan is repaid.

State banking commissions

The regulatory powers of the federal banking agencies overlap with those of the state banking agencies, which rule upon charter applications in their respective states and regularly examine all state-chartered banks. The states also have rules prescribing the minimum amount of equity capital for individual banks and frequently place interest-rate ceilings on deposits and loans. Many states in recent years have imposed restrictions on the growth and formation of bank holding companies, requiring state approval before a holding company may be formed or, once formed, before it can acquire additional authorities, consider the new bank's prospects for earnings, the convenience and needs of the public in the area to be served, and the potential for damage to existing financial institutions if a new charter is granted.
One of the areas in which state banking law currently is supreme is that concerning branch banking. Since the McFadden Act of 1927, the federal government has allowed the states to determine whether commercial banks operating within their borders will be permitted to establish any branch offices and, if so, under what circumstances. Today, 15 states forbid full-services branch offices. These so-called unit-banking states are situated mainly in the Midwest and south and include taxes, Kansas, Nebraska, and Colorado. However, as we saw earlier, there is a definite trend toward greater use of branching and holding company activity in most pats of the United States. Recent examples include Florida, which until 1978 was a unit-banking state and now permits limited branching on a countywide basis. The state of New York converted to statewide branching in 1976 following an experiment with limited branching in designated regions. Most experts predict that in future years branch banking in one form or another will spread across the United States as needs for larger banking organizations and new financial services increase.

Reserve requirements and excess reserve

Money creation by banks is made possible because the public readily accepts claim on bank deposits (mainly checks) in payment for goods and services. In addition, the law requires individual banks to hold only a fraction of the amount of deposits received from the public in cash or near-cash reserve, thus freeing up a majority of incoming funds for the making of loans and the purchasing of securities. We need to look more closely at these so-called reserve requirements bank must meet, since they play a key role in the money-creation process.
Under current federal law, banks and other depository institutions must hold reserves in cash or in deposit form behind their transaction accounts and time and savings deposits. These reserve requirements are linked to the size of the depository institution and require that a specified percentage of all incoming deposits must be placed either in an account at the Federal Reserve Bank in the region or as cash in the bank's vault. Vault cash and deposits at the Fed constitute a bank's holdings of legal reserves- those assets acceptable for meeting reserve requirements behind the public's deposits. In 1980, following passage of the depository institutions deregulation and Monetary Control Act, all deposit-type financial institutions (including commercial banks, mutual savings banks, savings and loan associations, and credit unions) were required to hold legal reserves equal to 3 percent of that portion of their transaction accounts (principally checking and NOW accounts) below $25 million and 12 percent for that portion over $25 million.
Each bank's legal reserve may be divided into two categories- required reserves and excess reserves. Required reserves are equal to the legal reserve requirement ratio times the volume of deposits subject to reserve requirements. For example, if a bank holds $20 million in checking and other transaction accounts and $30 million in savings deposits and the law requires it to hold 3 percent of its transaction accounts and 3 percent of its savings deposits in legal reserve , then required reserves for this bank are $20 million ×3%+$30 million×3 %,or $1.5 million.
Excess reserve equal the difference between the total legal reserves actually held by a bank and the amount of its required reserves. For example, if a bank is required to hold legal reserves equal to $1.5 million but finds on a given date that it has $500,000 in cash on the premises and $1.5 million on deposit with the Federal Reserve Bank in its region, this bank clearly holds $500,000 in excess reserves. Since legal reserve assets earn little or no interest income, most commercial banks try to keep their holdings of excess reserve as close to zero as possible. Indeed, the larger banks frequently run deficits in their required reserve position and must borrow additional legal reserves from other banks or attract more funds from their customers to cover the deficit.

The channels through which central banks work

Later on, we will examine in some detail how the Federal Reserve System affects domestic and international economic conditions. It is useful at this point, however, to give a brief overview of the channels through which modern central banks influence conditions in the economy and financial system. Central bank policy affects the economy as a whole by making:
1-Changes in the cost and availability of credit to businesses, consumers, and governments.
2-Changes in the volume and rate of growth of the nation's money supply.
3-Changes in the wealth of investors as reflected in the market value of their security holdings.
The central bank has a number of policy tools at its command which it can use to influence interest rates, the prices of securities, and the level and growth of reserve in the banking system. In the United States the principal policy tools used by the central bank are open market operations, changes in required reserves held by depository institutions, and changes in the discount rate on central bank loans. In turn, changes in interest rates, security prices, and bank reserves influence the cost and availability of credit. If borrowers find that credit is less available and more expensive to obtain, they are likely to restrain their borrowing and reduce spending for both capital and consumer goods. This results in a slowing in the economy's rate of growth and perhaps a reduction in inflationary pressures. Second, if the central bank can reduce the rate of growth of the nation's money supply, this policy will eventually slow the growth of income and production in the economy due to a reduction in the demand for goads and services. Finally, if the central bank raises interest rates and therefore lowers security prices, this will tend to reduce the market value of the public's holdings of stocks, bonds, and other securities. The result is a decline in the value of investors´ wealth, altering borrowings and spending plans and ultimately influencing employment, prices, and the economy's rate of growth.

The goals and channels of central banking

Central banking is goal oriented. Since World War II the United States and several other industrialized nations have accepted the premise that government is responsible to its citizens for maintaining high levels of employment, combating inflation, and supporting sustained economic growth. This is a relatively new idea since, in earlier periods, governments were assigned a much smaller role in the economic system and much less was expected of them by their citizens. It was felt that "automatic" mechanisms operated within t economy to provide stability and high employment in the long run. One of the bitter lessons of the Great Depression of the 1930s was that these mechanisms can break down and that innovative and skillfully managed government policies may be needed to restore the economy's stability and growth.
Central banking in the United States and in most other nations is directed toward four major goals:
1- Full employment of resources.
2- Reasonable stability in the general price level of all goods and services.
3- Sustained economic growth.
4- A stable balance of payments positions for the nation vis-à-vis the rest of the world.
Through its influence over interest rates and the growth of the nation's money supply, the central bank is able to influence the economy's progress toward each of these goals. Achievement of all these goals simultaneously as proven to be exceedingly difficult, however, as the recent track record of the economy demonstrates. One reason is that the goals often conflict. Pursuit of price stability and an improved balances of payments position, for example, may require higher interest rates and restricted credit availability- policies which tend to increase unemployment and slow investment spending and growth. Central bank policy making is a matter of accepting trade-off (compromises) among multiple goals. For example, the central bank can pursue policies leading to lower rate of inflation and a stronger dollar but probably at the price of some additional unemployment and slower economic growth in the short run.
Central banking in most Western nations, including the United States, operates principally through the marketplace. Modern central banks operate as a balance wheel in promoting and stabilizing the flow of savings from surplus-spending units to deficit-spending units. They try to assure a smooth and orderly flow of funds through the money and capital markets so that adequate financing is available for worthwhile investment projects. This means, among other things, avoiding panic in the market due to sudden shortages of available credit or sharp declines in security prices. However, most of the actions taken by the central bank to promote a smooth flow of funds are carried out through the marketplace rather than by government order. For example, the central bank may encourage interest rates to rise in order to reduce borrowing and spending and combat inflation, but it does not usually allocate credit to particular borrowers. The private sector, working through demand and supply forces in the marketplace, is left to make its own decisions about how much borrowing and spending will take place at the current level of interest rates and who is to receive credit.

The role of central banks in the economy

Control of the money supply
Central banks, including the Federal Reserve System, perform several important functions in a modern economy. The first and most important of their functions is control of the nation's money supply.
What is money? Money is anything which serves as a medium of exchange in the purchase of goods and services. Money as another important function, however-serving as a store of value, for money is a financial asset that may be used to store purchasing power until it is needed by the owner. If we define money exclusively as a medium of exchange , then the sum of all currency and coin held by the public plus the value of all publicly held checking accounts and other deposits against which drafts may be issued (such as NOW accounts) would constitute the nation's money supply. If we define money as a store of value, on the other hand, then time and savings accounts at commercial banks and other nonbank financial intermediaries, such as credit unions and savings banks, would also be considered important components of the money supply. However we define money, the power to regulate its quantity and value was delegated by Congress early in this century to the Federal Reserve System. The Fed has become, not only the principal source of currency and coin (pocket money) used by public, but also the principal government agency responsible for stabilizing the value of the dollar and protecting its integrity in the international financial markets. Why is control of the nation's money supply so important? One reason is that changes in the money supply are closely linked to the changes in economic activity. A number of studies in recent years have found a statistically significant relationship between current and lagged changes in the money supply and movements in the nation's gross national product (GNP). The essential implication of these studies is that, if the central bank carefully controls the rate of growth of money, then it can influence the growth rate of the economy as a whole.
Another important reason for controlling the money supply is that, in the absence of effective controls, money in the form of paper notes or bank deposits could expand virtually without limit. The marginal cost of creating additional units of money is close to zero. Therefore, the banking system, the government, or both are capable of increasing the money supply well beyond the economy's capacity to produce goods and services. Because this action would bring on severe inflation, disrupt the nation's payments mechanism, and eventually bring business activity to a halt, it is not surprising that modern governments have come to rely so heavily upon centrals banks as guardians of the quantity and value of their currencies. The Federal Reserve System operates almost daily in the financial markets in an attempt to control domestic price inflation in order to protect the purchasing power of the dollar at home, while occasionally intervening in foreign currency markets to protect the dollar abroad.
Stabilizing the money and capital markets
A second function of central banking is stabilization of the money and capital markets. The financial system must transmit savings to those who require funds for investment so that the economy can grow. If the system of money and capital markets is to work efficiently, however, the public must have confidence in financial institutions and be willing to commit its savings to tem. If the financial markets are unruly, with extremely volatile fluctuations in interest rates and security prices, or if financial institutions are prone to frequent collapse, the public´ confidence in the financial system might well be lost. The flow of capital funds would dry up, resulting in a drastic slowing in the nation's rate of economic growth and a rise in unemployment. All central banks play a vital role in fostering the mature development of financial markets and in ensuring a stable flow of funds through those markets.
Pursuing this objective, the Federal Reserve System will, from time to time, provide funds to major securities dealers when they have difficulty financing their portfolios so that buyers and sellers may easily acquire or sell securities. When interest rates rise or fall more rapidly than seems consistent with the nation's economic goals, the Fed will again intervene in the financial markets. The central bank may changes the rates it charges banks on direct loans or engage in securities trading in an attempt to moderate rate movements.
Lender of last resort
Another essential function of central banks is to serve as a lender of last resort. This means providing liquid funds to those financial institutions in need, especially when alternative sources of funds have dried up. For example, the Federal Reserve through its discount window will provide funds to selected deposit-type financial institutions, upon their request, to cover short-term cash deficiencies. As we will soon see, before the Fed was created, one of the weaknesses in the early financial system of the United States was the absence of a lender of last resort to aid to aid financial institutions squeezed by severe liquidity pressures.
Maintaining the payments mechanism
Finally, central banks have a role to play in maintaining and improving a nation´ payments mechanism. This involves the clearing checks, providing an adequate supply of currency and coin, and preserving confidence in the value of the fundamental monetary unit. A smoothly functioning and efficient payments mechanism is vital for carrying on business and commerce. If checks cannot be cleared in timely fashion or the public cannot get the currency and coin that it needs to carry out transactions, business activity will be severely curtailed. The result might well be large-scale unemployment and a decline in both capital investment and the nation's rate of economic growth.

Bank Loans to Business

Commercial banks are direct competitors with the corporate note and bond markets in making both long-and short-term loans to business. At year-end 1980 total commercial and industrial loans extended by banks reached $330 billion, accounting for 35 percent of all loans granted by commercial banks operating in the United States. Business loans are the single largest asset item at most banks, regardless of their size. Moreover, commercial banks grant their loans to a wide variety of firms covering all major sectors of the business community.
In recent years the Federal Reserve Board as carried out surveys of business lending practices by banks across the United States. The Federal Reserve Survey indicates that bank loans to business firms tend to be short-term or medium-term maturity. For example, short-term commercial and industrial loans averaged just less than four years. Moreover, the short-term loans-which are used principally to purchase inventories, pay wages and salaries, and meet other current expenses-average considerably larger at most banks than long-term business loans, which are taken out mainly to purchase equipment and expand physical facilities.
The Federal Reserve survey suggests that longer-term business loans tend to carry higher average interest rates than shorter-term businesses loans. this is due, in part, to the greater risk associated with long-term credit, Moreover, yield curves have usually sloped upward in recent years, calling for higher average rates on long-term loans. especially interesting is the high proportion of business loans today which carry floating rather than fixed interest rates, the larger and longer-term a business loan is, the more likely its rate will float with market conditions. For example, just 35 percent of the sort-term business loans included in the August 1980 Federal Reserve Survey of U.S. banks carried floating interest rates, while almost twice as many of the long-term business loans-68percent-had floating rates. Clearly, banks become more determined to protect themselves against unexpected inflation and other adverse development through floating interest rates as the maturity and average size of a business loan increases.

Issuing Banker's Acceptances by International bank

Banker's Acceptances are time drafts used mainly to finance the shipment of goods or commodities. Similar to a letter of credit, the acceptance is a bank‘s promise to pay after a certain number of days, issued on behalf of one of its customers. It substitutes the bank‘s credit standing in place of the customer‘s credit standing.
with a banker‘s acceptance the bank agrees to pay a seller of goods when the time draft expires. for example, an exporter and importer may agree upon " 60-day sight" terms on the shipment of certain items, this tells us that the exporter will receive payment from a bank 60 days following the date when the issuing bank affirms that the drafts and certain documents associated with the transaction are in good order. Once this is affirmed, the issuing bank will stamp "Accepted" across the face of the draft. the bank‘s stamp is a guarantee of payment (in our example, in 60 days from date of the drafts), and it make the acceptance a negotiable instrument. the exporter may sell (discount) the acceptance to a bank or other investor and thereby receive payment before the draft‘s due date.
Acceptances have a number of desirable features for multinational banks and for exporters and importers of goods. they reduce risk associated with the shipment of goods by giving exporters a bank‘s guarantee of payment. That guarantee enables importers to tap numerous sources of supply and find those goods available on the best terms. Acceptances are a high-quality financial instrument used by banks as a reserve of liquidity. As we noted above, they may be discounted in advance of maturity with securities dealers and other commercial banks. Another advantage is that banks selling acceptances do not have to include the contingent liability associated with each acceptance as a deposit for purposes of calculating reserve requirements.

Assisting in the marketing of Eurocurrency Bonds by international banks

In recent years multinational banks have become active as agents, underwriters, and, in some instances, investors in the rapidly growing market for Eurobonds. A Eurobond is a debt security denominated in a currency other than those of the countries where most or all of the security is sold. For example, An American automobile company may desire to float an issue of long-term bonds to raise capital for one of its subsidiaries operating in Greece. The company might issue bonds denominated in British pounds (or even dollars) to be sold in several countries in Western Europe through an underwriting syndicate made up of banks, securities dealers, and other firms.
Most Eurobonds are denominated in dollars; tough substantial amounts are also denominated today in marks, guilders, pounds, and francs. These bonds generally carry maturities ranging from 11 to 15 years. Eurobonds normally are straight debt offerings, though warrants and conversion features occasionally are attached to improve the marketability of a particular issue. The majority are callable bearer bonds with coupons attached.
Large multinational banks assist the Eurobond market in several ways. Major Banks such as Morgan Guaranty Trust Company of New York have established international clearing systems to expedite the delivery of bonds traded in the secondary market. Banks and security brokers are the principal intermediaries through which both old and new Eurobonds find their way to the long-term investor. The borrower-a government or large corporation-usually contacts a major international bank and asks it to organize a syndicate to place a new issue. At this point a consortium will be formed, embracing at least four to five American, British, Belgian, French, or German banks and a bank located in the borrowing country. The consortium typically agrees to subscribe to the Eurobond issue at issue price minus a commission (usually in the 2 to 3 percent range). Institutions in the consortium will then organize a large group of banks and securities dealers as underwriters in several countries. Sometimes more than 100 banks are in cluded in the underwriting syndicate. Once formed, the underwriting group gives the borrowers a firm offer for its bonds, and it receives funds immediately. The underwriting institutions will then place the issue with a large, geographically diverse group of investors representing many different countries.

Accepting Eurocurrency Deposits and making Eurocurrency loans.

International bank accept deposits denominated in currencies other than that of their home country. Thus, London banks will accept deposits denominated in dollars and other major convertible currencies. Eurocurrency deposits are used to pay for goods shipped between countries, as investment vehicles because they pay a competitive rate of return and as a source of loanable funds for banks.
Eurocurrency deposits may be loaned in the interbank market, usually on an unsecured basis, to corporations, governments, and other large wholesale borrowers. The majority of Eurocurrency loans carry floating interest rates based, in most cases, on London Interbank Offer Rate (Known in the trade as LIBOR) for three-month and six-month Eurocurrency deposits. The market for Eurocurrency loans is extremely competitive, with the spread over deposit rates averaging no more than one eighth of 1 percent. Eurocurrency credit normally goes to borrowers with impeccable credit ratings. Often, several multinational banks will spread the risk of international lending by forming a syndicate and jointly participating in single currency loan

Commercial Banks in the Federal Funds Market

Commercial banks and other depository institution must hold liquid assets in a special reserve account, equal to a fraction of the funds deposited with them by the public. Only vault cash held on the premises and reserve balances kept with the Federal Reserve Bank in the district count in meeting this legal reserve requirement. Frequently, commercial banks (especially small banks) hold more legal reserves than the law requires, Because these reserve earn little r no income, most bankers active in the money market try to dispose of any excess legal reserves in their possession, even if they can only lend the funds overnight.
Banks are aided greatly in this endeavor by the fact that their legal reserve requirement is calculated on an average basis over a week. the reserve requirement is stated as a daily average for seven days stretching from Thursday to the following Wednesday, Moreover, Federal Reserve regulations allow the manager of the individual bank‘s money desk-the department responsible for keeping tract of the bank‘s legal reserve position-to base the current week‘s legally required reserve holdings on the level of deposits prevailing two weeks earlier. Current Federal Reserve regulations also permit the money desk manager to use the amount of vault cash held two weeks before to satisfy a portion of the current week‘s reserve requirement.
because the amount of vault cash is known in advance, the money manager‘s key problem is to adjust the Bank‘s reserve balances held at the Fed to the right level. That is,
Required reserves for a bank this week - Vault cash holdings of two weeks ago= required average daily deposits held at the Federal Reserve this week
Each week the money desk manager will try to make sure that the bank‘s average deposit balances at the Fed hits or comes close to this required level. the Federal fund market is an indispensable tool for this kind of daily reserve management, especially for the largest and most aggressive banks, which hold few reserves of their own. the majority of Federal funds transactions are 24-hour (overnight) loans to cover reserve deficiencies. There is a trend in the market, however, toward longer-term Fed funds loans for banks and other depository institutions with "permanent" reserve needs. Indeed, many large U.S. banks today borrow virtually their entire reserve requirement on a more-or-less-permanent basis from the Federal funds market

Is Consumer Borrowing Excessive?

Are consumers too heavily in debt today? Have they jumped in over their heads? Certainly, the total volume of household debt outstanding is huge in both absolute terms and relative to most other sectors of the economy. However, to judge whether consumer borrowing is really excessive, that debt should be compared to the financial assets consumers hold. These assets, presumably, can be drawn upon to meet any interest and principal payments that come due on consumer borrowings. That while the volume of consumer debt has increased rapidly in recent years, the volume of household financial assets also has grown rapidly. For example, in 1980 financial assets held by U.S. households exceeded their outstanding liabilities by about $3 trillion. Moreover, the absolute size of that financial asset cushion has increased dramatically over the past three decades. In 1970, for example, the spread between household financial assets and liabilities was 1.4 trillion and in 1960, only $742 billion.
When we measure the ratio of consumer liabilities to financial assets, however, the picture is not so optimistic. This ratio has nearly doubled since 1950, increasing from less than 20 percent to more than 30 percent. Whether the liability-financial asset ratio has reached an "excessive" level depends, of course, upon economic conditions and the educational level and degree of financial sophistication of individuals and families. If the average consumer today is better educated and more capable of managing a larger volume of debt, a higher ratio of liabilities to financial assets in household portfolio is probably not an alarming development. Moreover, the total wealth held by consumers includes not just their financial assets but also their real estate-homes, automobiles, furniture, etc. while we have no really reliable measure of the volume of real estate held by consumers, it is obvious that the total wealth of individuals and families (including both and financial assets) far exceeds their debt obligations.

Credit Discrimination Laws

The civil rights movement has also had an impact on the granting of consumer loans in recent years. Among the most important new civil rights laws involving consumer credit are the Equal Credit Opportunity Act of 1974 and its amendments in 1976, the Fair Housing Act of 1968, the Home Mortgage Disclosure Act of 1975, and the Community Reinvestment Act of 1977. the fundamental purposes of these laws is to outlaw discrimination in the grating of credit due to the age, color, marital status, national origin, race, religious affiliation , or sex of the borrower. They are motivated by growing public support for fair and equal treatment in both public and private transactions and a greater measure of social responsibility in the allocation of credit. These new laws represent a major shift of focus in the regulation of the financial marketplace. Heretofore, the laws and regulations governing the behavior of lenders have stressed safety and the making of sound loans. Today, however, the lender must be able to justify in terms of fairness and objectivity, not only the loans that are made, but also those that are not made.

Debit card

Until recently, commercial banks were the only major financial institutions actively involved in the plastic card field. Other than banks, the other major issuers of cards were retail department stores and oil companies. This situation changed rapidly during the 1970s, however, as nonbank financial institutions (principally credit union, mutual savings banks, and savings and loan associations) successfully invaded the plastic card market using debit cards. While a credit card permits the customer to buy now and pay later, debit cards are merely a convenient way of paying now. A debit card enables its users to make deposits and withdrawals from an automated teller ("money machine") and also to pay for purchases by direct electronic transfer of funds from their own account to the merchant‘s account. Debit cards are also used for identification and check-clearing purposes and to access remote computer terminals for information or for the transfer of funds.
An important feature of debit cards is their potential for the complete elimination of checkbook float. Electronic funds-transfer systems activated with a debit card will take only seconds instead of days (as checks now do) to move money from one account to another. Overall, the outlook for debit cards is excellent. The fact that many credit-card users do not take advantage of the credit feature but merely use their card for convenience in shopping suggests that three is a market for debit-card services.
Both the credit card and the debit card offer significant opportunities to financial institutions to develop new services and open up new markets. The overall cost of consumer lending can be reduced by encouraging small borrowers to use a revolving charge-card account rather than negotiating separate loans each time funds are needed. Credit and Debit cards linked to money machines and point-of-sale terminals can provide the means for moving funds in many different directions-for purchases of goods and services, for additions to savings, and for investment. Most, if not all, consumer financial services-credit, savings, and checking-may be offered through card programs, offering the consumer greater speed, convenience, and accuracy in record keeping.

Credit-Card Users

Credit-Card is used for very different purposes depending upon social class, education, income, and lifestyle of the user. Customers who use their credit cards merely as a substitute for cash are referred to as convenience users. These people tend to be in the upper-middle or top income earning brackets and do not necessarily seek out stores accepting their cards. Customers who purchase large items (such as furniture, appliances, and gifts) or maintain large outstanding credit-card balances are referred to as installment users because they pay only a portion of their outstanding balances each month. These individuals frequently are in lower and middle- income brackets.
For both convenience and installment users, the principal advantage of credit cards is convenience. There is no minimum number of transactions for which the card must be used. Also, as two or three cards have become more widely accepted in thousands of stores, the number of different plastic cards needed by the customer has been reduced. The installment feature of the credit card is a major attraction because it functions as a revolving line of credit. In addition, the card itself serves to identify the customer and records pertinent information when the privilege of using the card is exercised.
To most merchants the credit card has been a positive financial innovation because it increases the potential number of customers and allows smaller firms to compete with larger ones. Banks and credit-card companies do collect a discount fee, however, on the dollar volume of a merchant‘s credit-card sales. This charge is designed to compensate the lender for the expenses of credit investigation, bookkeeping, and collections. the actual discount fee charged is negotiable but typically is inversely related to the volume of a merchant‘s sales and the average size of credit-card purchases. A store with membership in a credit-card plan deposits card sales slips along with other receipt in its account at a bank or other financial institution. If the receiving financial institution is merely an agency rather than a card -issuing institution, it forwards the credit slips through correspondents to the card issuer. It is the card-issuing firms who generally bear the full risk of buyer default or fraud, though some risk also may be shared with participating agency institutions.
Today, the largest credit-card programs generally operate at a profit. In the beginning, however, most card programs were confronted with substantial losses. Both credit delinquencies and losses due to fraud were high, due in large part to indiscriminate mass mailing of cards to customers. Moreover, the heavy cost of processing many small purchases of goods and services was not fully considered. Also, most banks and credit-card companies under-estimated the problem of controlling bad-debt losses. Today, however, the major credit-card programs in the United States are at least 20 to 30 years old. This long-term experience with operating problems has paid off in recent years. Nationwide acceptance of cards and the card interchange program have pushed the volume of activity in the largest card programs beyond the break-even point.

financial disclosure and consumer credit

A number of important new laws have appeared in recent years designed to protect the consumer in dealings with lending institutions. One major area of emphasis in recent consumer legislation is financial disclosure- making all relevant information about the terms of a loan contract available to the borrower before a commitment is made. The basic assumption is that an informed borrower will be a wise user of credit. Moreover, if all important information is laid out "on the table" before a loan agreement is reached, this many encourage the consumer to shop around to find the cheapest and most-convenient sources of funds. However, there is considerable debate today on whether consumer-protection legislation has really accomplished its goals. Both lenders and borrowers are confronted with a confusing array of laws and regulations which encourage violations and may be of little benefit to the consumer.

Credit and debit cards

One of the most popular forms of installment credit available to consumers today comes through the credit card. Trough this encoded piece of plastic, the consumer has instant access to credit for any purchase up to a prespecified credit limit. More recently, another piece of plastic- the debit card-has made instant cash available and check cashing much easier. The growth of credit and debit cards has been truly phenomenal to date, and the future looks equally promising. Current estimate suggest that there are more than 800 million credit and debit cards in use worldwide.
in the united states today a major battle for credit-card customers is shaping up among some of that nation‘s largest banks, savings and loan associations, credit unions, and mutual savings banks. Many of these institutions have launched aggressive advertising campaigns, sending out millions of inventories to customers to join the nationwide VISA and master Charge credit-card systems. Aggressive marketing of credit cards represents an attempt to change the whole competitive climate of consumer banking in the United States. In the future a wide array of new financial services is likely to be offered through plastic credit-and debit-card programs. Such services might include consumer revolving credit lines and preauthorized borrowing, interest paid on surplus credit-card balances, optional credit repayment plans, and the payment of other household bills.
Many of these consumer-oriented financial services are already offered on a limited basis in selected markets across the United States. In the future customer will need to make fewer trips to their bank or other financial institution because transactions will be handled mainly over the telephone or through a conveniently located computer terminal, either in the home or in easily accessible public locations. The hometown financial institution will lose much of its convenience advantage for local customers. It will be nearly as convenient for the customer to maintain a checking, savings, or loan account. In short, the ticket to many, perhaps most, financial services will be a plastic credit card or debit card-and electronic processing of consumer financial date across great distances.

The risks of international lending

For one thing, lending funds in the international arena is risky-probably more risky, on average, than domestic lending. Political risk-the risk that government laws and regulations will change to the detriment of business interests- is particularly significant in international operations. Governments are frequently overthrown and confiscation of private property is a common occurrence in many parts of the world. There is also currency risk- the risk associated with changing relative prices of foreign currencies. the value of property pledged behind an international loan will fall if the currency of the home country is devalued, thus eroding the lender‘s collateral. Geography, too, works against the international lender of funds. The larger distances which frequently separate lender borrower make it more difficult for the bank loan officer to see that the terms of the loan are being adhered to.
Beginning in the late 70s the Federal Reserve Board, Comptroller of the Currency, and Federal Deposit Insurance Corporation inaugurated semiannual surveys of foreign lending by approximately 140 U.S. Banking organizations. The principal concern of these regulatory agencies was that U.S. multinational banks were overly committed to loans in certain countries where political and economic risks were unusually high. if this were the case, it might threaten the confidence of the public in the stability and soundness of this nation‘s largest banks. By June 1980, the federal banking agencies discovered, nonlocal loan credits extended by the most-active multinational banks totaled $266 billion, while loans to local borrowers in the markets where the banks‘foreign offices were located totaled only about $70 billion. However, most loans extended by U.S. multinational banks were made to industrially developed nations and to OPEC Oil-producing countries. Only $66 billion- about one quarter-of the total of all foreign loans were directed at less-developed, non-oil-producing nations.
Nearly 60 percent of the loans extended by U.S.-based international banks flowed to residents of Switzerland and other developed nations in the group of ten and to offshore banking centers where these large banks regularly conduct their business. In addition, nearly three quarters of the loans to distant nations were short term (maturity of one year or less), with other banks representing the largest borrowing group. It seems clear that, on the whole, multinational banks are relatively conservative lenders, directing their credits mainly to large bank, corporate, and governmental borrowers situated mainly in Europe and among the major oil-producing countries of the Middle East. The combination of regulatory pressure and the inherent risks of international risks of international lending have encouraged U.S. multinational bankers to issue mainly short-term loans to established borrowers with strong credit ratings.

multinational banking corporations

The term multinational corporation usually is reserved for large nonfinancial corporations with manufacturing or trading operations in several different countries. However, this term is equally applicable to the world‘s major commercial banks, most of whom have their home offices in Canada, the United States, and Great Britain, but have established offices worldwide. In terms of sheer numbers, however, it is the largest U.S. banks which have accounted for most of the growth in multinational banking during the past 10 years