WASHINGTON – The Consumer Financial Protection Bureau is facing renewed pressure by consumer groups and think tanks to move forward with a plan that would rein in overdraft programs.
The latest salvo came Tuesday, when the Pew Charitable Trusts released a study that found overdraft programs remain an expensive source of credit and need significant reform.
"What began as an occasional courtesy has now become a frequent and harmful practice throughout our banking system," said Nick Bourke, director of consumer finance at Pew.
Whether the CFPB will have the chance to move forward with a proposal remains unclear. The agency recently listed overdraft as part of its "pre-rulemaking" agenda and it has released its own studies suggesting that consumers are paying too much in overdraft fees. But with President-elect Donald Trump due to take the White House next month, the agency appears likely to find itself under attack from every branch of government, perhaps curbing its ambitions.
For their part, some industry observers argue the problem isn't with banks and credit unions – and it should be up to the consumer to know how much money they have in their account.
"Overdraft isn't being caused by the banks. It is being caused by a consumer who doesn't know how much money they have on deposit," said Lawrence Kaplan, of counsel in the global banking and payments systems practice of Paul Hastings. "As a result there is an issue that the consumer needs an incentive to not spend more money than they have."
Kaplan argued that bouncing checks used to be considered a criminal activity and "these fees are charged when someone starts spending someone else's money."
"It should sting so you don't engage in that behavior," said Kaplan.
All-Time Overdraft Highs for CUs
Overdraft revenue continues to be a significant source of non-interest income for credit unions, and while CUs have long touted themselves as a more consumer-friendly alternative to banks – frequently citing lower fees in that argument – overdraft revenue at credit unions is rising at a faster pace than at other types of financial institution, hitting its highest level ever during the third quarter of 2016.
According to Mike Moebs, economist and CEO at Moebs $ervices in Lake Forest, Ill., overdraft revenue has risen by 1.2% since 2015, and while banks and thrifts have only seen a slight increase, CUs lead the pack with a 3.4% increase. As of Q3, credit unions have brought in $6.1 billion in overdraft revenue, compared to $26.8 billion for banks and thrifts. In the last five years, overdraft revenue at banks and thrifts has risen by 2.29% (from $26.2 billion in 2011 to $26.8 billion today), compared to nearly 13% for credit unions (from $5.4 billion to $6.1 billion).
"Overdraft price has remained constant over the past four years," Moebs wrote in a recent report. "Yet volume has increased 3.6% for the same four-year period. In addition, credit unions are seeing a surge in overdraft revenue as a result of 47% of the banks discontinuing free checking, whereas about 80% of CUs have stayed with free checking." At the same time, Moebs noted, credit unions have seen historic growth in the last five years as anti-bank sentiment has propelled millions of consumers to migrate their accounts from for-profit banks to credit unions, where free checking and overdraft protection are more prevalent.
Smaller = Cheaper?
The Pew study did find that smaller banks are limiting the penalty fees compared to their larger counterparts. In its review of 45 small banks between $360 million and $1 billion of assets located in 36 states, Pew found that smaller institutions generally charged less in fees and were less likely to reorder transactions to maximize costs.
"About half of the largest banks in this country have some kind of a reordering process," said Bourke of a practice that involves processing a customer's most expensive transaction first, followed by smaller transactions.
The practice can lead to a customer over-drafting when the higher, more costly transaction is processed and then incur additional charges as the smaller transactions are cleared. What could have been a $35 overdraft fee could surge depending on how many transactions are processed after the initial overdraft and result in additional penalties. Many banks allow more than $90 in fees to be accumulated in a single day.
Bourke said the trend is changing as some banks have begun altering their policies not to reorder transactions, but "the smaller banks tend to not do transaction reordering."
But Kaplan said consumers should just be more careful.
"When they reorder the checks that might not always be the consumer's deliberations, but they still wrote more debits than they have money," he said.
The study also found that smaller banks usually charge less for overdraft. The median fee charged by the small banks was $32, with 88% of them disclosing that they charge between $28 and $36, while the median for larger banks was $35, with 72% disclosing that they charge between $35 and $38.
CFPB's Proposal
The CFPB is currently weighing whether to issue a proposal that would place restrictions on overdraft programs. Consumer groups are pushing the agency to limit high-to-low transactions as part of eventual plan.
A 2014 CFPB report found that just 18% of account holder's end up paying 91% of overdraft and nonsufficient fund fees and a separate Pew study found that 7 out of 12 heavy over-drafters make less than $50,000 a year.
"There are some rather simple fixes that would help people," said Bourke.
Pew is also seeking to limit the number of overdraft fees to six per year -- a recommendation the Federal Deposit Insurance Corp. has endorsed – improve disclosures, and ensure fees are proportional to an institution's cost of providing the overdraft credit.
As Moebs noted, overdraft has become a valuable source of revenue for institutions that rely on the fees as a revenue source and help offset the expenses associated with providing free checking accounts.
"The original overdraft fees were designed to discourage customers from bad behavior, but then they became a source of non-interest income," said Ben Jackson, a director at Mercator Advisory Group. "The problem is that we have lived with so-called free checking for a while because overdraft fees and debit card interchange made it possible to offer accounts without charging fees. Managing accounts, printing cards and statements, maintaining systems, and even branches all cost money."
Bourke agreed that FIs may find it more difficult to offer free checking accounts if overdraft fees are limited, but said having the costs known upfront is a better alternative.
"Whether it is a monthly a maintenance fee or whether it is a clearly stated finance charge for a loan – that is the proper way to do it," said Bourke.
Kaplan agreed that "the banks should say these are the rules and it should be clear" but that providing more disclosures might not help.
"The problem with every other kind of disclosure… you are going to be giving them another piece of paper they are going to toss or it is going to be online and they are never going to read it," said Kaplan.
Industry representatives said that if overdraft fees and other non-interest income continues to drop, banks and credit unions will have to make up costs in other ways.
"There will likely come a day when banks need to convince accountholders that they should pay for the value they are getting with all the services that come with an account," Jackson said.
In its study, Pew scored Ally, Charles Schwab Bank, Discover Bank, HSBC, and USAA among the large banks with the best overdraft policies following their recommended best practices.
"There are some efforts afoot in the banking community to address some of the worst practices in overdraft," he said, but that is no substitute for a new rule. "There is a pretty broad consensus that the current overdraft system has a lot of downsides."
Pew is also urging the CFPB to include a payment test exception for banks and credit unions as part of a separate proposal that restricts small dollar lending. In its most recent form, an ability-to-repay test would be required for short-term, small-dollar loans. But an earlier proposal included an exemption if the loan was structured as an installment loan and the payments did not exceed 5% of the borrower's gross monthly income.
"What the banks and credit unions need are very clear and simple rules so they can take the best parts of overdraft – the simplicity the automation the low cost of origination and marry it with a providing a safe, small installment loan and that is going to require the regulators to simplify the rules around small-dollar credit," said Bourke.
