Defaults on credit card debt continues to soar and it is about to get worse for the banks issuing the cards. A proposed change in a Federal Accounting Standard could jack up the default rate by a third requiring banks to increase their reserves which in turn would decrease the capital available to lend.

So what does that mean for the consumer?

Consumers who are behind on the bill from their credit card should seriously consider contacting the bank and negotiating a discounted settlement. Using a credit counseling service is a good idea so the offer is reasonable and there is a plan in place to pay the settlement. Savings of thirty to forty percent or more are possible.

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.

Bringing these loans back on the books is going to have a significant impact on the amount of cash a bank needs to cover the reserve. To give you an idea of the magnitude of this rule change, American Express says it will have to add $28 billion in loan liabilities while Citigroup says it will have to add over $98 billion! Didn’t we just bail these guys out?

Billions of dollars will be needed to cover the cash reserve requirement once those new loans are added to the books. Banks know that at least 10% of the loans are bad and the potential for that to go up is very real. The more defaults, the more the reserve needs to be replenished. As a result, banks are motivated to accept settlements for less than the amount owed. In fact some banks are making the first contact with card holders who are behind offering discounted deals.

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.

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