Fed Nears Decision on Plan To Charge Overdraft Fees

Two years ago, the Federal Reserve floated a controversial proposal to curb the multi-billion-dollar exposure it incurs in operating the nation's payment system.

The plan: Make banks pay a fee when their reserve accounts dip into the red during the day.

Complaints in Abundance

Now, after two public comment periods and rounds of private meetings with unhappy bankers, Fed staffers say they are nearing a final decision on how to implement the proposal.

Banks and corporations have complained that the fee would unduly increase expenses, be too complex to implement, and necessitate costly computer systems to monitor overdrafts.

What's more, because the objections vary significantly from bank to bank, the Fed has been unable to sort through the tangle of conflicting interests and reach a compromise acceptable to broad segments of the industry.

Nonetheless, Fed staffers say they have had enough industry input to move ahead.

The key remaining stumbling block, they say, is how to measure overdrafts caused by checks and automated clearing house transactions.

Measurement Is Key

"As soon as we can get the measurement proposals ironed out, the Fed will act on this," said Bruce J. Summers, deputy director of reserve bank operations and payment systems for the Federal Reserve Board.

Another Fed aide, Florence Young, said the board would likely act on the proposal by next March.

At the center of the dispute are the so-called daylight overdrafts that many banks incur during the business day in their Fed accounts. These overdrafts, which currently average $140 billion a day, occur when a bank using the Federal Reserve's wire-transfer network transfers out more funds than it has on account. The deficits are typically covered by the end of the day, as incoming wires arrive.

Facilitating the Traffic

The overdrafts -- which amount to interest-free Fed loans -- act as grease for the payment system, allowing banks to send wires without awaiting incoming ones.

But in the mid-1980s, the Fed grew increasing concerned about the growing deficits. It feared that a bank with a large overdraft position would suddenly fail. That would not only leave the Fed with a multibillion-dollar exposure, but might also spur the failure of other banks waiting to receive payments from the collapsed institution.

In 1986, it moved to curb its exposure. It set a limit, called a net debit cap, on the amount of overdraft an institution could incur. The cap, based on a complex ratio in which the bank's capital was a key component, was reduced two years later.

Fees Proposed in 1989

The next phase of the risk-reduction plan -- to charge a fee for overdrafts -- came in June 1989. Initially, many institutions opposed the concept, saying it would be too expensive.

However, a number of them now are willing to live with the idea rather than face another reduction in overdraft caps. They feel that the fee, though potentially costly, would allow banks to continue borrowing money.

The Fed is thinking of charging the equivalent of a quarter of a percentage point interest on overdrafts that exceed a specified amount of an institution's capital. That would work out to about $6.85 a day for an average deficit of $1 million.

Most affected would be 10 giant banks that account for about 80% of all overdrafts. These banks would pay a combined average of $54 million a year in fees under the plan. But some charges would be incurred by most of the 300 largest banks.

The most controversy now centers on how pricing will be applied for checks and automated clearing house items.

Ironically, these transactions account for a relatively small dollar volume of bank transactions. The Fed processes some $1.2 trillion daily in wire transfers and securities transactions, compared with $52 billion in checks and $24 billion via the ACH. Including these transactions would raise the current $140 billion daily overdraft by $30 billion, the Fed holds.

The Fed is proposing that checks be posted to reserve accounts hourly between 11 a.m. and 6 p.m. Eastern time.

Banks are complaining that it would be extraordinarily complicated to keep track of their checking activity because items could be sent from any of 141 "availability zones," or Fed office zones.

The loudest objections are coming from correspondent banks that have built their business around checking service. They are concerned that the proposal will hurt their competitiveness either with the Fed or with other banks.

One of the biggest concerns is the cost of building new monitoring systems. The Fed's own system is estimated to cost about $2.3 million to build, and about $1.2 million a year to run.

In his comment letter, Huntington Bank executive vice president Gerald R. Williams estimated that his institutions would have to install monitoring software that would cost as much as $700,000.

Many banks criticized the idea of treating checks and ACH items as if they were equally as risky as wire transfers. "We don't think there's any risk associated with float," said Robert Fitzgerald, president of the Chicago Clearing Corp.

"They're suggesting changing the way the whole industry deals with batch processing debiting and crediting, without any idea of the ramifications. They're trying to do too many things at once." [Graph Omitted]

PHOTO : Florence Young Expects plan by March

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