The controversy over bank overdraft policies has intensified to the point where some financial institutions have abandoned the fees, the product, or both. Who can blame them, when bank CEOs testifying on Capitol Hill regularly get blasted over the “obscene profits” they make on the backs of consumers. (It didn’t help that one bank chairman famously christened his yacht “Overdraft.”)
For the Consumer Financial Protection Bureau, overdrafts are exhibit A in the agency’s ongoing campaign against “unfair, deceptive and abusive” bank practices. And CFPB is just getting warmed up.
A little perspective would help. Years ago overdrafts were a consumer problem, not a banking profit center. People who bounced checks endured returned check fees and a bad reputation, at the least. Then a small corps of consultants began to teach community banks, especially, how to make money off overdrafts. That led to controversies over the order in which checks were presented, in some cases resulting in multiple overdrafts triggered by first clearing a big check, such as a mortgage payment. The complexities of overdraft grew as ATM withdrawals and then point of sale use of debit cards became more common.
“Simply eliminating fees for overdrafts — and changing how financial institutions pay out or don’t pay out on the attempted consumer payments — doesn’t address the root cause of consumers’ problems, which is illiquidity.”
— Ron Shevlin, Cornerstone
The current CFPB leadership has resolved to attack what it calls “junk fees” and other charges it sees as unfair. Bureau Director Rohit Chopra vowed going into the job that one of his targets would be institutions that he saw as repeat offenders.
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CFPB Sends a Message with Regions’ Second Overdraft Action
In September 2022 CFPB announced a settlement with Regions Bank over overdraft practices. The settlement includes refunds of $141 million to affected consumers as well as a $50 million penalty. The bank was embroiled in an earlier settlement involving overdrafts, in 2015, resulting in a settlement requiring refunds of over $49 million in fees and a fine of $7.5 million.
A key issue in the most recent case concerns a type of overdraft charge called an “authorized-positive fee.” In simple terms, this is a fee for an overdraft that happens when the consumer checks their balance and has sufficient funds for a given transaction at that time. In between verifying the balance and the transaction hitting their account, some other charge comes in, drawing down the balance sufficiently to cause an overdraft, triggering an overdraft fee. In 2015 CFPB addressed this in a supervisory report, in which it said it considered it to be an “unfair and deceptive practice.”
In recent years Regions, like many other major financial institutions, has been revamping overdraft policies, practices and pricing. The bank’s statement on the latest case indicates that Regions had stopped charging the fee cited above more than a year before the settlement was announced.
Overdraft Makes a Good Target:
Ever since the fintech wave began, overdrafts have been a sore spot that many of the new competitors probed with their marketing efforts.
The overall tone: Those bad old banks have been dinging you, but we’ll remove the pain from overdrafts. Some even promoted two-day advance access to payroll deposits, a practice that some banking institutions have been adopting.
Meanwhile, an updated study on overdraft practices and fees by Curinos estimated in September 2022 that enough voluntary changes had been made by institutions to produce a projected decrease of annual overdraft fees of 68% from the 2008 through the end of 2023. “If current trends continue,” the update stated, “consumers could save more than $28 billion in the five-year period between 2021 to 2025.”
During fall hearings on Capitol Hill, Bank of America Chair of the Board and CEO Brian Moynihan testified that a series of changes made in early 2022 was significantly driving down overdraft charges at BofA. In June and July, the first two months after BofA made the changes, fees fell by 90% over the same two months in 2021.
So, is the industry’s best path away from many of these charges?
It’s just not that simple.
Why Eliminating Overdraft Programs Isn’t the Answer
In commentary accompanying a survey report concerning overdrafts, Ron Shevlin, Chief Research Office at Cornerstone Advisors, makes a detailed case for the need of doing something besides simply razing all overdraft programs.
“Overdraft fees are frequently criticized as unfair to lower-income consumers, but it’s important to remember that they also protect consumers and facilitate commerce,” writes Shevlin. “If regulators truly want to be consumer-friendly, they should be monitoring how frequently transactions are returned or declined — when checks bounce or debit card transactions don’t go through — because a returned or declined item harms the entire payments channel, from consumer to bank to merchant.”
Some institutions have repriced the service, but others have either eliminated it or introduced accounts that don’t permit it. In the report Shevlin warns that if overdraft service goes completely away, all three groups just mentioned will see consequences. Consumers will be charged returned payment fees by merchants and be marked down on their credit scores. Merchants will see greater need to process returned payments, a time-consuming task, especially for smaller firms. For banks, Shevlin thinks the increased pressure on revenues would increase pressure for smaller institutions to merge — which many consumers wouldn’t like.
Shevlin’s report, based on a consumer survey, disputes the claims that overdraft fees are “hidden,” indicating that nearly three out of five consumers know when their institutions offer the service.
The research also found a significant generational split. For example, in terms of using overdraft by mistake or on purpose:
- Baby Boomers used it 70% of the time by mistake, 30% intentionally.
- Gen X, 64% by mistake, 36% intentionally.
- Millennials, 50%/50%.
- Gen Z, 50%/50%.
The study found that while at least three-quarters of each generation sampled were glad their institution covered their overdraft, 11% of Gen Z didn’t care either way.
“The media often conveys the idea that there is an overdraft epidemic among Americans,” Shevlin writes, but his research indicates that there’s more to it. 60% of the overall sample never overdrew their account in 2021, and 29% did so once or twice. However, “the problem is more acute among younger consumers,” the report indicates.
“Roughly six in ten Gen Zers overdrew on their checking account in 2021, as did 56% of Millennials. Among Gen Zers, nearly one in five overdrew three or more times.”
— Cornerstone Advisors study
Across the entire survey nearly half of the sample felt that their institution’s overdraft fee is fair and like the service. 30% like the service but don’t feel the fees are fair. The study found that more than three quarters of people who used overdraft or paid nonsufficient funds charges in 2021 incurred less than $100 in fees.
Many Consumers Aren’t Tuned Into Overdraft Debate
In his commentary, Shevlin points out that Cornerstone’s research finds that it’s inconclusive whether changing overdraft policy influences consumer opinions of a financial institution.
“The overdraft issue is mainly being heard in the financial industry echo chamber instead of in the world at large,” Shevlin writes, “with over half of respondents saying they had not seen any news about overdraft protection. Interestingly, only 12% of survey respondents said that any news they had seen left them with a more negative opinion about overdraft. Why make drastic changes if people don’t have a substantial negative opinion of overdraft?“[Emphasis added]
Shevlin makes an interesting point, given concerns that overdraft controversy has given the industry a shiner and the hope that institutions’ changes will improve its reputation.
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Many financial institutions have changed their overdraft policies over the past year. Have consumers taken notice? Just one in four consumers said their primary checking account provider has changed its overdraft fee policy.
Lack of awareness on the part of Baby Boomers skews this somewhat. Among both Millennials and Gen Zers a third of the sample were aware that their primary checking account provider had revamped its overdraft policies.
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What Do Consumers Really Need? Help With Liquidity
A key point brought out by the Cornerstone research is that use of overdraft service is a symptom, more than a cause. Many people have liquidity issues, spending money they don’t yet have in their checking accounts. The dominant reasons are unexpected large expenses (cited by 40%) and unexpected income shortfalls (cited by 35%). A third of the sample — 33% — cited excessive spending.
The Cornerstone study probed how people would cover expenses they couldn’t afford. Younger generations tend to borrow from family and friends if in a crunch, while Boomers (being substantially the eldest generation now) tend to rely on credit cards that they roll over. Many Boomers and Gen Xers actually said if they were unable to pay a bill, they would not pay it even though they would incur a late charge.
Significantly, more consumers, except the Boomers, said if they wanted a short-term loan they would go with payday lenders rather than taking a short-term loan from a bank or credit union. One out of ten Gen Zers would consider pawning some belongings.
In separate research, Moebs Services indicates that many habitual overdraft users eventually go to payday lenders because they can obtain credit for longer periods and for larger amounts than they can through overdraft service. Many actually use payday credit to bring their overdrawn checking accounts back into positive numbers.
“Depositories need fee income to offset unprofitable checking accounts. Payday lenders want to make larger loans to achieve more profitability. The battleground is overdraft users,” says Mike Moebs, head of the firm.
BNPL: One Overdraft Option Banks Could Adopt
Solving the industry’s overdraft PR problem by eliminating NSF fees or taking other steps is at best a stopgap and doesn’t address revenue issues. Nor, says Shevlin, does it address less desirable alternatives taken such as payday loans of not paying bills. Based on what consumers told Cornerstone, Shevlin makes some suggestions in his report.
One is to explore buy now, pay later financing. Even as the well-publicized problems of major nonbank players like Klarna continue, the lending technique has appeal to people who might otherwise lean on overdrafts. The report found that half of the consumers surveyed would use a BNPL option if their debit card was refused at the point of sale. Similarly, three out of five would choose BNPL for a purchase of $500 that they couldn’t cover with checking account funds. Only 14% said they would instead choose a 90-day personal loan from a financial institution.
However, the study also asked consumers how quickly they would want money for a $500 purchase they couldn’t cover. 46% said they would prefer an overdraft option that they could use immediately, while 22% would wait a day for a short-term loan and 17% would be willing to wait up to four hours for a fast access short-term loan. Another 15% said they would be willing to wait up to five days to obtain a line of credit.
“Nearly four in ten consumers would be willing to pay $35 to get immediate access to $500 with repayment within ten days,” the report states. “Another 35% are willing to pay a $10 monthly charge to be able to access the $500 within 24 hours.”
Shevlin suggests referrals to short-term fintech lenders could be a good move, if the institution can’t do it themselves. Another option is to provide overdrafts through a managed program, where each user has a risk profile and their access to their service is tailored.