Rising overdraft fees have long been a source of contention among financial institutions, consumers and regulators in both the U.S. and the U.K. While these fees have historically proven to be a steady flow of revenue for retail banking institutions, that return has come at a high long-term cost — negative consumer satisfaction and sentiment, periodic legislative punishment and regulatory tinkering.
Add to this the fintech factor. New digital players, such as Chime and Varo, which are not beholden to such fees as a source of income, have been promoting the message of “no overdraft fees” as a way to attract consumers and drive them away from traditional banks and credit unions.
Traditional institutions don’t have to let neobanks win the goodwill war. They have a tremendous amount of consumer data and can seize the opportunity to find a better way forward for their depositors. What they need is to apply the right tools.
With analytics powered by artificial intelligence, financial institutions have the capability to understand client cash flow behavior and help consumers anticipate potential balance issues. By utilizing these advanced solutions at their disposal, banks and credit unions can foster greater trust and satisfaction among consumers, in turn delivering a boost to their bottom line in the long run and ultimately making the appetite for overdraft fees a thing of the past.
A Habit-Forming Charge that Hits Many in Tight Circumstances
Overdraft charges have steadily increased over time, plateauing over the last few years at $33 per occurrence according to a 2019 Bankrate study. While these so-called “penalty fees” represent a source of consternation for consumers and a compliance issue for regulators, they comprise a meaningful source of income for many institutions— so much so that a number of consulting firms still specialize in this concept. For banks with over $1 billion in assets, overdraft fees make up 7%-8% of banks’ net income, according to the Public Interest Research Group.
“In the U.S., 9% of accounts are frequent overdrawn — meaning that they overdraw their accounts more than 10 times a year and incur 79% of overdraft fees.”
These added expenses have a tremendous impact on people’s daily lives. A Financial Conduct Authority (FCA) report in the U.K. found that fees are concentrated on customers who can least afford to pay them — 10% of U.K. account holders pay for half of all overdraft charges. In the U.S., the situation is even more concentrated: 9% of accounts are frequent overdrawn — meaning that they overdraw their accounts more than 10 times a year and incur 79% of overdraft fees.
In 2009, U.S. federal law required institutions ask consumers to opt in to overdraft fee arrangements, barring the fees (and coverage of such withdrawals) without that affirmative choice. Since then, fees have plateaued, but still have not materially declined.
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Fees Damage Trust and Draw Government Attention
Penalty fees like overdraft charges result in consumer complaints and costly service calls. However, they also impair customer trust. Millions of U.S. households have opted to manage their finances without a transaction account as a result of these spiraling fees.
In the U.K., the situation has prompted regulators to take a decisive step to act on behalf of consumers, requiring banks to comply by April 2020 with new rules banning the charging of fixed fees for overdrafts and to do more to identify customers showing signs of financial strain.
The Financial Conduct Authority stated that it was undertaking “the biggest overhaul … for a generation” to correct “a dysfunctional overdraft market.”
While U.K. banks are being forced to take action, U.S. institutions have the opportunity to innovate and act before regulators intervene further. By implementing solutions that promote consumer-centered solutions that help anticipate issues, financial institutions can reduce depositors’ financial issues and encourage trust.
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AI Can Protect and Empower Consumers
The technology to accomplish those goals exists in artificial intelligence. By using advanced methods to analyze transaction data, banking institutions can more effectively understand individual consumers’ cash flows and anticipate when they may be at greatest risk of incurring overdraft fees.
This sophisticated modeling takes into account deposit and payment behavior, including scheduled, recurring and patterned expenses, in order to help consumers anticipate future balance issues and avert fees before they occur. Several financial institutions are already implementing such solutions as part of their digital experience, with the goal of helping customers and strengthening their brand promise. Some personal financial apps have likewise attempted to assist in managing transactions accounts to avoid overdraft expenses.
Some current examples:
- Huntington Bank has implemented a potential low-balance insight as part of its Heads Up program, intended to look out for customers.
- Ally Bank has integrated potential low-balance insights into its revamped digital experience, consistent with its brand of being their customers’ “Ally.”
- Wells Fargo has implemented a low-balance insight warning for its checking customers under its Predictive Banking label.
Yet, one big question remains: In exchange for doing right by their customers and helping them anticipate penalty fees, will financial institutions be forced to absorb the revenue hit?
In short, yes, for some. Institutions that help consumers anticipate low-balance issues may see penalty fees decline over time. However, they stand to gain in consumer trust, satisfaction, balance growth and deeper relationships. By providing customers an insight that a balance situation is likely to occur prior to their next deposit, institutions are in a position to advise the customer on what action to take to resolve the liquidity issue. For example, in the case of a pending balance issue, the bank can advise the consumer to transfer money from an external institution; sign up for overdraft protection, or accept a pre-approved unsecured line to smooth upcoming cash flow issues.
And here’s the flip side to this: The same models that provide early warning of overdraft potential can also identify when a consumer has excess liquidity in their transaction account.
Banks can nudge consumers with a personalized insight to transfer a specific amount to savings without jeopardizing the payment of upcoming expenses. This proactive advice helps consumers establish a savings buffer that may help avert future balance issues and fees.
These intelligent insights are proactive. This can demonstrate that the institution is acting in the interest of the consumer while also driving greater value for the bank. The long-term benefits of this approach, including boosts in customer satisfaction, far outweigh the potential decline of penalty fees. But the truth is those are unsustainable over time. And they provide ammunition for new entrants that can attack traditional players’ dependence on the fees.
The clincher: The positive potential economics of driving higher customer satisfaction is further supported by the McKinsey Retail Banking study, which shows that consumers who are highly satisfied are 2.5 times more likely to open new accounts/products than those who are merely satisfied.
Jody Bhagat has been a guest on the Banking Transformed podcast.