Banks should revamp overdraft policies before Congress does it for them
By Joel Schwartz for American Banker
Overdraft practices are having a moment. It’s more than Sen. Elizabeth Warren, D-Mass., pressing bank executives on Capitol Hill — complaints about them are now regularly featured in popular TikTok videos. Overdraft practices are in the spotlight because the problems associated with them go beyond consumers’ disdain for hidden fees.
When the Consumer Financial Protection Bureau conducted a study of overdraft practices and users in 2017, it found that the most frequent overdraft users only accounted for 9% of bank accounts — but paid 79% of the overdraft and non-sufficient funds (NSF) fees. Overdrafters tend to have lower median deposits. When looking at the overall set of banking customers, the study showed that most overdrafts occur because of timing or inattention issues, not from financial emergencies.
This suggests that overdraft services may be targeted most at vulnerable populations — bad optics during an era of consumer-protection-focused legislation and litigation as well as stakeholder capitalism.
As the regulatory environment heats up in the wake of the fallout from the global pandemic, large banks are trying to find solutions that help consumers as they navigate through periods when they find themselves strapped for cash. The recent spate of offerings from challenger institutions and announcements from mainstream banks that are eliminating overdraft fees show financial institutions are looking for better overdraft solutions. This is encouraging, yet the offerings are inconsistent, and most don’t address the real issue.
Challenger institutions have been focused on “no fee” overdraft offerings, and in the wake of the pandemic, they’ve added more features and flexibility. They allow customers to overdraw their accounts up to a certain dollar amount, which can vary from $10 to $100, depending on the institution, without incurring a fee. Some are beginning to provide a flexible window in which customers can get their balance back to zero without penalty.
Mainstream banks have started to replicate this strategy. Others are getting creative by offering lines of credit for overdrafts based on the customers’ past checking account behavior. Some are reordering the way that charges are posted, prioritizing credits over debits to reduce the incidence of overdraft.
Both challenger and traditional institutions have stipulations on these “no fee” benefits. They maintain the same overdraft policies for the majority of their account types. “No fee” overdraft benefits are only available for certain accounts, leaving them out of reach of many consumers. Some require monthly deposit minimums. Others require a linked checking or savings account. Most charge a fee for the “no overdraft fee” account. There’s often a lag between when the transaction causing the shortage is processed and when the customer is notified.
Today’s “no fee” overdraft programs also don’t address the underlying reason that regulators view overdraft practices as predatory: the lack of transparency and customer control. While customers may opt in to overdraft services, they don’t have any choices when they face an account shortage and fees automatically process.
The bank is deciding the order in which transactions are processed and which items are paid or declined. The bank may approve a clothing purchase but return the water bill. Customers face negative consequences, including the ripple effect of late fees and bad credit.
Over time, with multiple overdrafts and rising fees, some people could become unbankable, making them reliant on payday loans and check cashers. That is the opposite of what regulators are looking to achieve. Putting the power in customers’ hands gives them freedom and a chance to protect their credit scores and reduce the risk they will become unbankable.
Standardizing a new model with transparency and customer control would provide benefits for financial institutions and extend beyond customer satisfaction and retention rates and into risk mitigation and operations.
In May, Rep. Carolyn Maloney, D-N.Y., said she intended to reintroduce the Overdraft Protection Act to crack down on predatory overdraft fees. This legislation could eliminate or reduce overdraft fees and introduce stringent disclosure requirements.
If legislation that looks like the Overdraft Protection Act does pass, or the CFPB institutes new regulations, those financial institutions that are making strides in their overdraft offerings will find that they still have a long way to go to ensure compliance.
That’s because even these newest offerings aren’t yet fully “transparent and fair,” as Maloney’s bill would require.
First, let’s discuss transparency. No solution today is robust enough in this area. That’s because customers still don’t get a chance to rectify their overdraft situation before payments are returned. They still can’t make any changes to the decisions that their institution makes about what is ultimately paid or not. Fees are still charged automatically and applied to every individual transaction.
Next, there’s the issue of fairness. All customers deserve visibility into how their institution addresses their account shortage and control over what gets paid. Even the most progressive overdraft offering is usually available for customers with one account type.
Today’s circumstances necessitate that we fully empower consumers to take control of their finances in the most upfront, transparent and fair way possible. This means that solutions need to be scalable and easy to implement, or they’ll never reach the populations that need them most.
If financial institutions deliver on this promise, they’ll do more than get ahead of impending regulatory changes. They’ll give customers more control, therefore securing customers’ loyalty at the beginning of an emerging new era of overdraft transparency for the financial services industry.