The real problem with bank overdraft programs is that they are stuck in the 1990s.

Regardless of regulatory or legislative changes, banks always will have customers who spend more than they have in their accounts, so the question is how to serve these customers, says Robert C. Giltner, consulting partner with Velocity Solutions Inc. in Wilmington, N.C.

Currently, most overdrafts programs take a one-size fits-all approach. Instead of allowing all customers to overdraw the same amount, say up to $500, banks need to set risk-based, individual overdraft limits on each account, he says. Those accountholders more likely to have the money to pay back overdrafts quickly get higher limits than those less likely to pay them back.

Velocity has come up with a software program where banks can download information from their core systems that measures customer overdraft risks based primarily on the number of deposits they make, the amount of the deposits, and how long they have been account holders. Giltner says most banks focus on average balance of accounts to rate customer risk, but customers who make a lot of deposits regularly are more likely to pay down overdrafts than those who make one deposit a month.

The top 30 banks already set daily, individual limits, Giltner says, but most small and mid-size banks still operate on a fixed-limit system that they set up over a decade ago.

Individual limits on how much someone can overdraw an account could lead to other changes like scaled pricing based on the size of an overdraft, Giltner says. "It will drive innovation because we will have the information to do it."

Another way of dealing with customers who routinely overdraw their accounts is to offer products that won't let them. Some banks plan to replace checking accounts - including debit cards - with prepaid cards branded with the MasterCard or Visa logo that can regularly be reloaded, and would be declined if there's not enough money in the account to cover the cost of that Slurpee or double-caramel macchiato.

Central Bank of Kansas City, Mo., plans to offer prepaid cards, paired with financial education, to chronic over-drafters, according to a report published by the National Community Investment Fund.

Instead of closing the accounts, the bank intends to give these customers prepaid cards that will allow them to continue using cards for transactions, pay down the overdrafts and fees they have incurred, and become better financial managers, all without the risk of further overdrafts.

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