CFPB's overdraft proposal exempts the small banks that need it most

Bloomberg News

A plan by the Consumer Financial Protection Bureau to slash overdraft fees comes with a major omission: Small banks, which are more reliant on overdraft revenue as a profit center than larger banks. Several dozen small institutions are among the worst offenders in targeting consumers for overdraft charges, experts say. 

The CFPB's proposal released last week would allow large financial institutions with more than $10 billion in assets to charge a breakeven fee or a maximum overdraft fee of between $3 to $14, under a rubric to be set by the bureau. If banks charge a higher amount than their costs, the CFPB will consider an overdraft charge to be a line of credit subject to the Truth in Lending Act, which requires disclosures of annual interest rates. 

Given small banks' outsized role in overdraft, some experts are questioning the CFPB's rationale, especially considering research that shows small banks' overeliance on overdraft revenue. 

"Exempting banks and credit unions that have under $10 billion in assets is a mistake because the bureau's rule doesn't touch some of the biggest offenders," said Aaron Klein, a senior fellow at the Brookings Institution and a former deputy assistant secretary for economic policy in the Treasury Department. "If overdraft is a profit center, then it's an extension of credit — and credit is regulated."

Some small banks continue to reorder transactions from high to low amounts, which can maximize fees, said Klein, citing his own research that found small banks and credit unions "are some of the biggest overdraft predators." 

The 211-page proposed rule would apply only to 175 large banks and credit unions. The CFPB also said it plans "to monitor the market's response" and determine whether "to alter the regulatory framework," for smaller institutions with less than $10 billion in assets.

"I see no way for small banks not to be affected by this," said Kristen Larson, an attorney at Ballard Spahr. "They're regulating the larger banks, but the smaller ones lose leverage because of the regulation." 

The CFPB may have exempted small banks in an effort to avoid convening a small business review panel, which is required for rules impacting small businesses, but would have delayed the proposal's release. Community banks and credit unions also could exert their political muscle in opposing a final rule if they were not exempted.

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"This is very much a part of the Biden administration's campaign, and they needed to get this out so they can say they are trying to tackle prices, however misguided that might be," said Nicholas Anthony, a policy analyst at the Cato Institute.

The flip side is that the CFPB may have to persuade a court that a final overdraft rule is not "arbitrary and capricious," which may be a harder lift if the bureau treats overdraft fees as finance charges when assessed by larger financial institutions but not by smaller ones. 

Rob Nichols, president and CEO of the American Bankers Association, said the CFPB has no legal authority to impose what he called a "price cap" on overdraft charges. Lindsey Johnson, president and CEO of the Consumer Bankers Association, called the CFPB's proposal "price setting" and claimed changes to overdraft services would impact whether banks could offer free checking accounts. 

The CFPB delved into the history of overdraft fees that began as a courtesy service to cover bounced checks in the 1980s. When financial institutions began extending overdraft services to debit card transactions, the volume of overdraft fees skyrocketed and the fee revenue began to influence banks' business models. 

Overdraft fees accounted for $10 billion in revenue in 2004, but skyrocketed to an estimated $25 billion by 2009, according to research by the Center for Responsible Lending. By 2019, under pressure from the CFPB, overdraft fee revenue had dropped to an estimated $12.6 billion. 

CFPB Director Rohit Chopra has repeatedly complained that the Federal Reserve Board used its authority — and did not rely on an interpretation of statute — to carve out an exception for overdraft charges from Regulation Z, which implements the Truth in Lending Act. 

"The question now is, if you're under $10 billion, why does any bank get an exemption from TILA?" asked Joe Lynyak, a partner at Dorsey & Whitney.

The CFPB's past research found that overdraft presents a serious risk to low-income consumers with roughly 9% of consumer accounts paying 10 or more overdrafts a year, accounting for close to 80% of all overdraft revenue. 

"Overdraft disproportionately targets lower-income minorities, stripping wealth — and it has been tremendously profitable for banks," said Klein, who cited some small banks that specifically target military personnel for overdraft charges and suggested regulators need to discourage such abuse. "Little banks and credit unions punch far above their weight in overdraft." 

Another wrinkle is that not all of the 175 large banks and credit unions that would be covered by the proposed rule have reduced overdraft fees. When Bank of America cut overdraft fees from $35 to $10 in 2022, other large and mid-sized banks followed. But many did not. 

"There may be an interesting industry split between banks that have already eliminated overdraft and those that are still reliant or using it as part of their business model," said Anthony at Cato. 

JPMorgan Chase and Wells Fargo accounted for roughly one-third of overdraft revenue reported by banks over $1 billion, according to the CFPB. Still, larger banks may have more leeway to replace overdraft fees with monthly fees, or by scaling back free checking account offerings. 

Larson said the CFPB has left the door open for future expansion of the rule to smaller institutions. 

"The fees will be really transparent, and then smaller institutions are going to be forced to make modifications or risk losing customers over this," she said. "In a competitive landscape, why would a consumer pay $24 or $35 for the same service? If smaller banks don't start following what these larger providers are doing, they're going to lose customers."

Larson is urging small banks to submit comments on the proposal by the April 1, 2024 deadline because of "the downstream impact to competition in the marketplace," she said. 

A final rule on overdraft fees is expected to go into effect in October 2025.