Recently there has been a flurry of articles criticizing discretionary overdraft services. My first reaction was to view the authors as zealot community activists with a paternalistic approach as self-appointed guardians who feel they, knowing what's best, must protect the uninformed public from themselves.
However, I couldn't dismiss the articles entirely because I agree with some of the concerns. That said, I want to respond to misleading portrayals of discretionary overdraft services and financial institutions that provide them.
Discretionary overdraft services are portrayed as being something new. Of the estimated 18,000 U.S. banks, credit unions and thrifts, the majority have been providing the service for years. Banks and thrifts have always extended overdraft services to their "good" customers and as of July 1, 2000, the NCUA amended its regulation to permit credit unions to offer similar services.
A Great Service
This is a great service! When a member writes a check for more than their account balance (assuming no existing line of credit or transfer agreement), the credit union has two choices: return it to the payee as insufficient (NSF) or pay it into the overdraft (OD). If returned, the credit union charges an NSF fee (typically the same as an OD fee). The payee often re-deposits the check potentially exposing the member to a second NSF fee. Payees typically charge returned check fees. In addition, there can be late charges, interest, embarrassment, lost time and credit report damage. Members in good standing with discretionary OD services pay only one OD fee per check and avoid other potential charges and embarrassment.
This service has been portrayed as "steering low and moderate-income customers to high-cost" service. NSF check activity is not limited to any segment of the population. Most Americans, regardless of income, live paycheck to paycheck and appreciate a little "wiggle room" sometimes. Overdraft programs involve amounts of only a few hundred dollars. Your members will tell you they much prefer that the credit union pay their checks OD rather than return them NSF. Credit unions can turn the NSF punitive experience into an "Overdraft Privilege".
With over 30 years in the industry, my experience is that virtually all credit unions are shining examples of community spirit, member service and goodwill. Providing overdraft services is consistent with good member service.
A question repeatedly raised is whether the fees associated with overdraft services are finance charges for the purposes of usury or disclosure. Over the years, the Fed, FDIC, NCUA, OCC, OTS and state and federal courts have consistently held that fees related to discretionary overdraft services are not finance charges for usury or disclosure. These services do not constitute extensions of credit subject to Regulation Z because the overdraft fees imposed are not finance charges as defined by the Regulation. Rather, these services involve nothing more than the discretionary payment of items that overdraw the member's account and the imposition of overdraft charges contracted for in the account agreement. The extension of the coverage of Regulation Z to such services would reverse over three decades of precedent relating to the treatment of discretionary payment of overdrafts.
The fact credit unions increase non-interest revenues by providing this service does not make it inherently bad. By providing services that deliver value and meet member needs, more people will choose to use the credit union's services and revenues will increase.
Often members do not have other accounts for fund transfers or do not have the desire or ability to qualify for credit services. Consequently, there will always be a demand for the $100 to $500 short term cash need. That demand can be met by credit unions or increasingly non-traditional financial services providers. I believe most people who use alternative financial service providers would be better served by a credit union.
Earlier, I said I agreed with some of the concerns surrounding overdraft services. I believe there are financial institutions and vendors who have taken a good thing too far. Overdraft services must be implemented prudently and responsibly. Members and the credit union's staff must clearly understand the service's features and benefits as well as the related policies of the credit union. Members must understand that this privilege is always at the credit union's discretion.
Don't use products names like "Overdraft Protection" or "Bounce Protection," which might imply a commitment to always cover checks. Member usage of the service should be monitored and the credit union should proactively counsel members on proper usage. Bottom line, financial services providers that aggressively advertise that they will "cover checks" have gone too far!
The Reg Guidelines
Regulatory guidelines are clear that an overdraft fee is not a finance charge for Regulation Z disclosure purposes except to the extent it exceeds the fee that would have been charged if the NSF check had been returned. The obvious concern is that any additional charges associated only with paying an item into the overdraft may create a Regulation Z issue. Credit unions should charge the same for OD and NSF services. Daily overdraft administrative fees are not recommended.
Finally, some ATM systems automatically add the overdraft limit into the balance given to a member. This may induce a member to inadvertently overdraw their account. It is recommended that ATM software systems be enhanced to differentiate between the ledger and available balance. Members should be educated so they understand the difference.
There is an old saying: "Be careful what you ask for; you just might get it." If opponents of discretionary overdraft services are successful in impairing credit unions' ability to provide overdraft services, I believe they will be harming the very groups they seek to protect. If credit unions are limited to providing these services to only those who apply and qualify for credit or account transfer services, there will be no choice but to return most checks NSF. We've already concluded that's not what members want nor is it in their best interest. Driving members away to alternative, unregulated financial services providers is not the answer and additional regulatory burden will only add cost.
I believe the answer lies in education and our free market system. If, as opponents of overdraft services insist, it is inherently bad and they have a better alternative, let them differentiate themselves by advertising and educating the public and exposing the abuses they claim exist. I believe in the American public and the right to select the financial services provider and services of their choice. With tens of thousands of financial services locations and unlimited access to financial services through the mail or over the internet, no one is forced to pay fees they believe to be unfair. If on the other hand, your members value the overdraft services provided by the credit union, let them choose for themselves. They don't need regulatory authorities making that decision for them.
Credit unions with the best service quality and financial performance use outside experts. Well-designed and properly implemented overdraft services will deliver the best member service and improved non-interest revenues. It truly is a "win-win" for the member and the credit union!
Ken Johnson is executive VP with Strunk & Associates, Houston, a provider of overdraft privilege services. Mr. Johnson can be reached at 512-291-5120 or at kjohnson strunklp.com.
