A checking account is a vital product that allows consumers to manage their money, deposit their earnings, and pay their bills. Not so for overdraft service.
Overdrafts used to be a courtesy that banks would provide to customers on rare occasions. Not anymore. Today, the high price average consumers pay for this service—$225 over the course of a year when they overdraw an account—pushes many of them out of the banking system altogether.
"What is often marketed as overdraft protection may actually be putting consumers at greater risk of harm," warned Richard Cordray, Director of the Consumer Financial Protection Bureau, when the agency released its overdraft white paper in June. The Federal Reserve Board also recognized the dangers of overdraft fees in 2010 when it implemented new rules requiring consumers to affirmatively opt into debit card overdraft service to tamp down fees from this product.
Unfortunately, the Fed's model opt-in form is not an example of clear disclosure. It doesn't lay out the options for overdraft or make clear that consumers who don't opt in will avoid high overdraft fees. A May 2012 survey by The Pew Charitable Trusts of consumers who had overdrawn their accounts over the past year using their debit card bears this out—finding that 54% of consumers didn't realize they had opted in.
While those who promote overdraft service say that consumers like and appreciate it, our research shows that's not the case. Over two-thirds of respondents think the service mostly hurts rather than helps consumers. The CFPB's white paper also illustrates this point, finding that consumers who opt in pay higher account fees and experience more involuntary account closures than those who do not. It turns out that checking accounts are one of the most complained-about products in the CFPB's database, averaging almost 1,000 complaints registered per month.
Supporters of overdraft services also claim that consumers don't want to be embarrassed at the register if they do not have enough money in their checking accounts, preferring that their transactions go through. Yet when we asked consumers specifically whether they would prefer to incur a $35 overdraft fee—more than half of the large banks charge $35 to $37 per overdraft—or have their transaction declined, 75% responded that they would prefer to have their transaction declined.
Moreover, despite the 2010 Fed rules, overdraft service still comes with significant risks. One problem is that the rules did not prohibit the practice of high-to-low transaction reordering, paying a consumer's largest transactions first, which can turn one overdraft into ten separate fees.
Continued regulatory gaps in overdraft service put consumers at financial risk and potentially expose them to high, unexpected costs for little benefit. The CFPB white paper found that overdraft and non-sufficient funds fees now make up more than 60% of bank income from consumer checking account fees. The paper lays the groundwork for new rules that would ensure transparency and reduce risk, thus making checking accounts far more competitive and efficient.
Our research demonstrates the immediate need for new overdraft rules. Our survey of consumers who had overdrawn their bank accounts with their debit cards found that almost three-quarters of them incurred an overdraft penalty fee—the most expensive form of overdraft. And our checking account research shows that most consumers have other options, among them an overdraft transfer service that links their checking account to a savings account and is significantly cheaper. (If the checking account is overdrawn, the difference is taken out of savings.) But what's missing is transparency: it's hard for consumers to choose a less expensive option if they don't know it exists.
Pew continues to urge the CFPB to write new rules on overdraft service. These rules should prohibit transaction reordering that maximizes overdraft fees, and they should require banks to post deposits and withdrawals in a fully disclosed, objective, and neutral manner. In addition, the rules should require that overdraft penalty fees are reasonable and proportional to the financial institution's costs in providing the overdraft loan. And they should require banks to provide account holders with clear, comprehensive terms and pricing information for all available overdraft options.
Susan Weinstock directs The Pew Charitable Trusts' safe checking work.