Banks shouldn't count on overdraft fees forever

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Over the summer, Democratic Sens. Cory Booker of New Jersey and Sherrod Brown of Ohio introduced legislation that would take a large bite out of the roughly $15 billion that banks collect annually from overdraft fees.

Their bill would ban such charges on debit card purchases and ATM withdrawals. It would also prohibit banks from charging more than six overdraft fees each year to the same customer.

The proposal may supply a handy campaign talking point for Booker and Brown, both of whom are considering presidential bids and seem eager to take aim at an unpopular industry. But for banks, that political fight is starting to look like a distraction from market forces that are poised to erode overdraft fee revenue in coming years.

Two emerging trends require close attention from bankers.

The first development is the rise of challenger banks such as Varo Money, Social Finance and Chime, which are targeting digitally savvy young adults. As these branchless upstarts seek to undercut the higher-cost business models of incumbent banks, unpredictable overdraft fees are an obvious vulnerability.

Chime, based in San Francisco, is opening more than 150,000 overdraft fee-free accounts each month. The company’s chief executive, Chris Britt, said in an interview that he anticipates the arrival of more startups with a similar value proposition. He also predicted that traditional banks will be reluctant to adapt their business models accordingly, because doing so can hurt their bottom lines.

JPMorgan Chase collected more than $1.8 billion in revenue from overdraft fees in 2017, according to an analysis of regulatory data by the Center for Responsible Lending. Bank of America and Wells Fargo both raked in more than $1.6 billion. Big banks typically charge around $35 per overdraft.

“They’re not going to rush to get rid of these fees, because they’re so substantial,” Britt said. “It’s very difficult for them to just pull the plug.”

But some big banks have taken notice — JPMorgan now has an overdraft fee-free digital bank account, and Wells Fargo is testing a similar product in certain regions. Smaller banks may eventually have to follow suit, particularly if the venture capital-backed startups achieve consistent profits.

The second trend that poses a threat to overdraft fee income is the industrywide push to adopt real-time payments. While there is no data on the subject available, experts believe that a sizable percentage of overdraft fees are levied in situations where the customer’s account has a positive balance when the card is swiped, but a negative balance when the payment is settled.

Many of those consumers know what their balance is at the cash register, and are essentially gambling that their accounts will still have enough money a day or two later to avoid the fee. If real-time payments achieve widespread adoption, people who live paycheck to paycheck would no longer have to roll the dice.

“The more real time you get, the less you have those timing issues,” said Steve Ledford, a senior vice president at The Clearing House, which launched a real-time payment system in 2017.

Lauren Saunders, associate director of the National Consumer Law Center, said that real-time payments have the potential to help people manage their money better.

“It’s really the certainty of when money will come in and when money will come out that can help people,” she said. “There’s also a psychological benefit of knowing that if something is due today, then I can pay it today, and it will get there today.”

It is important to note some caveats about the adoption of real-time payments in the United States.

While the Federal Reserve is pushing for the establishment of a real-time system that connects every U.S. bank and credit union, a lot of technical questions have yet to be resolved, including whether overdrafts should be allowed. And even after a system is up and running, it is not clear whether it will be used all that much in the consumer realm.

Still, bankers would be foolish to assume that in the age of real-time payments, overdraft fees will remain as lucrative as they have been over the last couple of decades.

“I think the transparency it would have could reduce overdraft a lot,” said Corey Stone, a former assistant director at the Consumer Financial Protection Bureau.

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