Credit card companies have long been in the practice of collecting data on cardholders for the purposes of determining credit risk for each current and future cardholders. The Federal Reserve Board is one of the major oversight and regulatory agencies for these card issuers. The Board frequently does research and issues reports about the industry. One recent report indicates that credit card lenders profile cardholders using merchant category codes. Collecting data on cardholders is known as “consumer profiling“. Profiling is a method that is used by card companies to collect data on cardholders and make changes and decisions about rules and regulations that govern the use of the card.
What is Profiling?
The practice of profiling initially was thought to only be used by a small handful of lenders and used simply to collect data. It was thought that this type of data collection did not have a big impact on cardholders and wasn’t used to make changes about lending regulatory decisions. Recent reports show that credit card companies may be using these merchant account codes to determine the risk factors associated with certain card holders and making decisions about the future of decisions relating to credit card agreements for certain borrowers who may be thought to pose a risk, making the practice of consumer profiling more widely used than initially thought.
Each establishment that accepts credit cards is assigned a merchant account. When a consumer makes a transaction using a credit card they are associated with a certain merchant account. Some merchant account codes are determined by lenders to be associated with risk factors. For example consumers who shop at pawn shops, frequent gambling establishments, or purchase adult entertainment are profiled by the lender to offer higher risk than those who are not associated with this type of purchase. Interestingly, mortgage lenders who have a high rate of foreclosure can look at zip codes of cardholders to determine the borrowers that pose a greater risk of foreclosure based on where they live. Profiling is used to make determinations not only about spending but about the person making the purchase.
Consumer profiling is based on several factors:
• Frequently visited establishments where a credit card is used.
• Shopping patterns.
• The category or merchant code associated with the service or product that was purchased.
• The cardholders mortgage lender.
• The form of credit card transaction.
• The goods or services that were purchased with the card.
• Cash advances
An Example
The practice of consumer profiling of credit cardholders came to light through a feature story done by Good Morning America back in 2009. Since then, consumer profiling has received a great deal of attention and criticism. The story highlighted by Good Morning America told of a situation where an American Express cardholder with an excellent payment history had his credit limit cut by over 60%. When the cardholder requested an explanation, the reason given by American Express was because the consumer profiling research indicated that a majority of other consumers who frequented the same establishments where this cardholder shopped had poor repayment credit history. This was not the case for this cardholder but he was lumped into a category not based on his spending but on the general information that came from profiling.
This story raised a great deal of controversy over the ethics surrounding consumer profiling. It seems that consumer profiling is still a practice that is very much alive in the credit card community. Unsuspecting consumers who never realized that they were being profiled with every swipe of the card may be more aware of the spending patterns that may put them in the risk pool.
The Problem with Profiling
Reports indicate that while consumer profiling may determine some useful information for lenders; it is largely inaccurate and ineffective in determining with certainty the risk level of a borrower based on a few merchant codes that come up on the credit card statement. Realistically, many people spend far beyond what is listed on their card. This method of profiling may be a very costly method of inaccurately profiling a risk that does not exist. Financially and ethically this profiling program has raised concern. Recent reports show that this program is largely inaccurate and costs cardholders money.
The credit card industries collect the data on their cardholders then filter this data to determine various different spending patterns. The patterns are then studied further to determine what spending patterns may pose risks to the credit card companies. As a result of those risks the card company, regardless of the individuals repayment history or individual spending patterns can make changes to the card agreements. This profiling may lead to a cut in credit limit, a rise in interest rates or a cancellation of the card.
The implementation of the CARD act has made it a little bit harder for changes to be made to cardholder agreements without advance notice. The consumer responsibility that goes with being a cardholder apparently extends far beyond responsible spending and good credit.
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