Deregulation in the Lending and Credit Industry: Paved With Good Intentions
Sharon L. Secor
December 02, 2007
Throughout the past several decades, a number of changes in federal banking industry regulations have made substantial differences in the everyday operations of United States credit markets. Beginning in the late 1960's, a number of legislative measures were introduced to reduce certain regulatory burdens on the banking industry and create a higher level of transparency. Many of these reforms were made with the stated goal of promoting fair and equal access to credit throughout the population.
Among the reasons cited by deregulation advocates for reform were the substantial disparities that existed among demographic groups in rates of credit availability, with minority groups and women much more likely to be denied credit than white males of comparable financial means. While the deregulation movement was meant to expand credit opportunities available to these groups, many argue that deregulation has done more harm than good, the easier credit standards contributing to soaring consumer debt levels and reckless lending practices.
The Truth in Lending Act was one of the first steps towards the goal of reforming banking regulations. Passed in 1968, this legislation was designed to ensure that consumers were informed of the the full terms of credit agreements, giving them the information necessary to assess the total cost of borrowing before entering into any contract. Meant to protect consumers from deceptive lending tactics, this legislation set the stage for the deregulation movement, its proponents working under the assumption that consumers provided with the tools to make informed decisions were better prepared to navigate a market with less restrictive regulations.
Comprehensive regulations were imposed on the banking industry after the onslaught of the Great Depression, meant to stabilize the banking industry and overall economy and help control risk. The FDIC system was developed in response to bank failures and economic upheaval during this period, providing insurance to consumers on bank deposits and creating a tightly structured banking system throughout the United States.
A system of regulation of thrift depository institutions, such as savings and loans and mutual savings banks, emerged during this era, mandated by the FDIC system in order to ensure the availability of affordable mortgage loans and savings vehicles to the working class, needs that had been largely neglected by the large commercial banks. Regulations on these banks were structured to ensure that these goals remained their priority. Among the regulations put in place with this system were stricter rules on bank branching, or geographic regulation, caps on the amount of interest paid on deposits and interest rates charged on loans, strict limits on services and products offered to consumers, and prohibitions against speculative investments.
Loosening these Depression Era regulations became the goal of deregulation proponents, especially during the 1970's as interest rates rose sharply and inflation soared. Dissatisfaction bred by these and other economic woes led to widespread distrust in the government's ability to manage the economy effectively, spurring calls for less government interference in the financial markets.
Furthermore, many advocates of deregulation pointed to the clear disparity in lending practices among the community banks. Credit applications submitted by women and minorities were declined at disproportionate rates by the local banks. Many community banks refused credit applications from certain neighborhoods or areas, no matter how credit worthy the applicant. Since strict geographic regulations virtually assured these local banks a monopoly on lending in their communities, consumers had no real recourse against such practices.
These issues, among others, led to a gradual deregulation of the banking industry, done in a series of small, targeted regulation changes throughout the late 1970's and early 1980's. Lines between the thrift establishments and commercial banks were blurred, allowing more flexibility in products and services that could be offered by both. Geographic regulations were eased, allowing more interstate banking activity, and thrift institutions saw the rate ceilings on deposits and lending phased out over time.
As long predicted by deregulation advocates, these changes lead to greater competition in the banking industry. As the market adjusted to these changes, some banks thrived while others failed, ill prepared for the new atmosphere of competition. Bank consolidations soared as larger banks consumed struggling smaller ones, allowing many of the large banks to move into new markets, creating a boom of banking institution expansions.
Consumer credit availability expanded also, as banks competed for customers with new products, competitive interest rates, and better service. Gradually, credit became more available to demographic groups that had been denied credit access when the community bank was the only option in town. Competition for business made many of the same bank officials who had turned away these consumers in the past eager for their business. Also, interest rate deregulation allowed banks to tailor rates on credit accounts or loans to the potential risk, allowing higher profits to be made on loans to consumers considered high risk for default. Credit card choices became more plentiful as deregulation made them more profitable for banking institutions, allowing banks more discretion over penalties, and fees, as well as interest rates.
However, not all the results of deregulation were for the better. Deregulation allowed banks to take on more risk, yet allowed them to keep FDIC insurance. With deposits fully insured and high profits to be made with risky loans, there was little incentive for a conservative approach to lending. Many economists attribute the savings and loan debacle of the 1980's to the deregulation process of the time. The same sort of risky behavior on the part of lenders is at the root of the current sub-prime mortgage foreclosure crisis, the lure of high profits from risky loans encouraging recklessness.
Rising consumer debt is another consequence of deregulation and the resulting expansion of credit availability. The proliferation of credit options and the relative ease of qualifying for them spurred many consumers to get in over their heads. Personal bankruptcies rose with the tide of increasing debt, and savings rates fell, leaving many consumers very vulnerable to changing economic conditions. The additional leeway in assessing fees and penalties given to banks and credit card companies gave rise to practices like universal default. Universal default means that any late or missed payment recorded on a consumer's credit report can be used as justification to raise interest rates on credit card accounts, even if payments on those accounts have been made without fail.
Banking deregulation has been an advantage to consumers in many ways, opening the market to many who had previously been left behind. However, consumers must be more diligent in shopping for credit , as looser regulation has made the credit markets a bit more treacherous to the uninformed or unwary consumer, weakening some of the protections that were once built into market regulations. Credit, used wisely, can be a step to financial security for the responsible and well-informed consumer. But, for the consumer that lacks the self control to limit debt, or the savvy to avoid the pitfalls of the market, such as aggressive fee structures and deceptive practices, credit mistakes can not only cause immediate financial hardship, but can cast a long shadow, affecting financial well-being for years to come.
Among the reasons cited by deregulation advocates for reform were the substantial disparities that existed among demographic groups in rates of credit availability, with minority groups and women much more likely to be denied credit than white males of comparable financial means. While the deregulation movement was meant to expand credit opportunities available to these groups, many argue that deregulation has done more harm than good, the easier credit standards contributing to soaring consumer debt levels and reckless lending practices.
The Truth in Lending Act was one of the first steps towards the goal of reforming banking regulations. Passed in 1968, this legislation was designed to ensure that consumers were informed of the the full terms of credit agreements, giving them the information necessary to assess the total cost of borrowing before entering into any contract. Meant to protect consumers from deceptive lending tactics, this legislation set the stage for the deregulation movement, its proponents working under the assumption that consumers provided with the tools to make informed decisions were better prepared to navigate a market with less restrictive regulations.
Comprehensive regulations were imposed on the banking industry after the onslaught of the Great Depression, meant to stabilize the banking industry and overall economy and help control risk. The FDIC system was developed in response to bank failures and economic upheaval during this period, providing insurance to consumers on bank deposits and creating a tightly structured banking system throughout the United States.
A system of regulation of thrift depository institutions, such as savings and loans and mutual savings banks, emerged during this era, mandated by the FDIC system in order to ensure the availability of affordable mortgage loans and savings vehicles to the working class, needs that had been largely neglected by the large commercial banks. Regulations on these banks were structured to ensure that these goals remained their priority. Among the regulations put in place with this system were stricter rules on bank branching, or geographic regulation, caps on the amount of interest paid on deposits and interest rates charged on loans, strict limits on services and products offered to consumers, and prohibitions against speculative investments.
Loosening these Depression Era regulations became the goal of deregulation proponents, especially during the 1970's as interest rates rose sharply and inflation soared. Dissatisfaction bred by these and other economic woes led to widespread distrust in the government's ability to manage the economy effectively, spurring calls for less government interference in the financial markets.
Furthermore, many advocates of deregulation pointed to the clear disparity in lending practices among the community banks. Credit applications submitted by women and minorities were declined at disproportionate rates by the local banks. Many community banks refused credit applications from certain neighborhoods or areas, no matter how credit worthy the applicant. Since strict geographic regulations virtually assured these local banks a monopoly on lending in their communities, consumers had no real recourse against such practices.
These issues, among others, led to a gradual deregulation of the banking industry, done in a series of small, targeted regulation changes throughout the late 1970's and early 1980's. Lines between the thrift establishments and commercial banks were blurred, allowing more flexibility in products and services that could be offered by both. Geographic regulations were eased, allowing more interstate banking activity, and thrift institutions saw the rate ceilings on deposits and lending phased out over time.
As long predicted by deregulation advocates, these changes lead to greater competition in the banking industry. As the market adjusted to these changes, some banks thrived while others failed, ill prepared for the new atmosphere of competition. Bank consolidations soared as larger banks consumed struggling smaller ones, allowing many of the large banks to move into new markets, creating a boom of banking institution expansions.
Consumer credit availability expanded also, as banks competed for customers with new products, competitive interest rates, and better service. Gradually, credit became more available to demographic groups that had been denied credit access when the community bank was the only option in town. Competition for business made many of the same bank officials who had turned away these consumers in the past eager for their business. Also, interest rate deregulation allowed banks to tailor rates on credit accounts or loans to the potential risk, allowing higher profits to be made on loans to consumers considered high risk for default. Credit card choices became more plentiful as deregulation made them more profitable for banking institutions, allowing banks more discretion over penalties, and fees, as well as interest rates.
However, not all the results of deregulation were for the better. Deregulation allowed banks to take on more risk, yet allowed them to keep FDIC insurance. With deposits fully insured and high profits to be made with risky loans, there was little incentive for a conservative approach to lending. Many economists attribute the savings and loan debacle of the 1980's to the deregulation process of the time. The same sort of risky behavior on the part of lenders is at the root of the current sub-prime mortgage foreclosure crisis, the lure of high profits from risky loans encouraging recklessness.
Rising consumer debt is another consequence of deregulation and the resulting expansion of credit availability. The proliferation of credit options and the relative ease of qualifying for them spurred many consumers to get in over their heads. Personal bankruptcies rose with the tide of increasing debt, and savings rates fell, leaving many consumers very vulnerable to changing economic conditions. The additional leeway in assessing fees and penalties given to banks and credit card companies gave rise to practices like universal default. Universal default means that any late or missed payment recorded on a consumer's credit report can be used as justification to raise interest rates on credit card accounts, even if payments on those accounts have been made without fail.
Banking deregulation has been an advantage to consumers in many ways, opening the market to many who had previously been left behind. However, consumers must be more diligent in shopping for credit , as looser regulation has made the credit markets a bit more treacherous to the uninformed or unwary consumer, weakening some of the protections that were once built into market regulations. Credit, used wisely, can be a step to financial security for the responsible and well-informed consumer. But, for the consumer that lacks the self control to limit debt, or the savvy to avoid the pitfalls of the market, such as aggressive fee structures and deceptive practices, credit mistakes can not only cause immediate financial hardship, but can cast a long shadow, affecting financial well-being for years to come.