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In recent days, the Consumer Financial Protection Bureau (CFPB) unveiled a new proposal to reduce overdraft fees to as low as $3. The proposed rule would apply to banks and credit unions with more than $10 billion in assets and could potentially cut billions of dollars in fee income for the nation’s largest financial institutions.
The CFPB plans to solicit comments from the public by April 1, with a regulation expected to take effect in October 2025.
The action followed the December release of the CFPB’s new report findings showing many consumers are still receiving unexpected overdraft and nonsufficient fund (NSF) fees, despite recent changes implemented by banks and credit unions that have eliminated billions of dollars in fees charged each year.
Even more, of the nearly one-quarter of survey respondents who received an overdraft or NSF fee last year, only 22% were expecting it. The CFPB’s report also notes that many of the consumers who were charged overdraft fees had access to a cheaper alternative, such as available credit on a credit card. And, among the households that incurred fees, 81% reported difficulty paying a bill at least once in the past year versus 25% for households that were not charged a fee.
If they aren’t already, financial institutions must conduct a risk assessment of their overdraft programs, including entities with under $10 billion in assets. Banks and credit unions must also weigh both the compliance and reputational risk of eliminating a significant source of revenue that some studies say is a significant consumer benefit.
As an example, a survey from the American Bankers Association (ABA) found that for a fourth year in a row, 9 in 10 consumers (88%) find their bank’s overdraft protection valuable. Nearly 8 in 10 consumers (77%) who have paid an overdraft fee in the past year were glad their bank covered their overdraft payment, rather than returning or declining payment. Additionally, 63% of consumers think it’s reasonable for banks to charge a fee for an overdraft, as opposed to only 24% who think it’s unreasonable.
For banks determining how to balance the potential risk and reward of overdraft protection programs, there are several questions they should ask:
The CFPB estimates that overdraft and NSF fees make up as much as two-thirds of fee income at banks while the NCUA attributes one-quarter of credit union fee income to overdrafts. Financial institutions should consider if their current level of fee income appears at odds with consumer-friendly behavior? How would eliminating overdraft income impact their bottom line? How would the bank make up for the lost income?
According to the FDIC, some banks that provided notice when customers first opted into overdraft programs did not provide sufficient notice when those programs changed. Financial institutions must assess whether they are updating disclosures for new and existing customers when their program changes. Additionally, they should ensure that staff are adequately trained in how to explain those changes and answer questions about overdraft. Ultimately, what is the process for updates?
The FDIC reported in its Spring 2022 Supervisory Insights that several financial institutions changed their automated overdraft protection program from a static limit to a dynamic limit but didn’t adequately disclose the change to consumers. A static limit is a fixed amount for the overdraft program whereas a dynamic limit is one that may change periodically based on the consumer’s account usage changes. The FDIC concluded that the lack of information endangered customers because they no longer had the information that they needed to avoid fees.
Financial institutions should review whether they have provided adequate disclosures to consumers regarding overdraft protection limits. If using a dynamic approach, are customers able to easily understand how and how often their limit will change or is it likely they will be confused? Is there a way to communicate this information clearly, or does it make sense to use a static limit?
According to the FDIC, consumers are harmed when they are charged multiple fees for re-presentment of an unpaid transaction and that these fees aren’t always made clear in disclosures. If a bank’s disclosures say NSF fees are charged “per transaction” or “per item” without specifying that the same transaction can cost a customer multiple NSF fees when re-presented, it may violate Section 5 of the Federal Trade Commission (FTC) Act. The FDIC advises eliminating this practice.
Banks should therefore review policies, procedures and disclosures for re-presentment and overdraft. Are they consumer friendly? Do they create a tangible benefit for customers? In the case of disclosures, are they clear and easy to understand?
Just 18% of account holders pay 91% of all overdraft fees, according to research from The Pew Charitable Trusts. Does that trend hold true for your financial institution?
Banks should consider whether using overdraft protection as an extremely high-cost credit tool is in the best interest of their customers. Do customers really understand the consequences? Are the fees a mild nuisance affecting mostly high-income customers who manage their money a little too casually or a burden on mostly lower-income customers that are struggling financially? Would it be more consumer friendly to offer alternative small-dollar loans at more reasonable rates? Can you justify the status quo?
Overdraft and NSF revenue is down significantly across financial institutions. However, the CFPB is still aiming for major regulatory changes that could cap fees and further limit income, making it critical that banks ask these and other questions to understand the potential risks of existing programs.
Banks must be able to identify issues that could be viewed as unfriendly to consumers. Doing so allows them to identify new controls or even new products and services that could make it easier for consumers to manage their money while developing alternative sources of fee income. This also allows banks to potentially defend their program to examiners and demonstrate that they are working to proactively ensure their overdraft program is a benefit to customers.
What banks shouldn’t do is wait for examiners to dig into their program. Regular risk assessments of overdraft programs are critical, including when changes are made, helping banks determine whether they’re worthwhile or if further changes are needed.
Rafael DeLeon is Senior Vice President, Industry Engagement for Ncontracts.
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