Lately the banking industry is beset by so-called strategic consultants pushing a highly addictive form of overdraft banking.
These consultants are selling increasingly aggressive overdraft policies to which some banks, under mounting earnings pressure, are succumbing but which more reasonable people might term usurious.
The new overdraft policies are unlike reasonably priced protection plans backed by balance transfers, unsecured credit lines, or credit card advances. Known by oxymoronic names such as Overdraft Courtesy or Bounce Protection, these products rely on manipulative direct marketing programs to encourage the weakest customers to write what bankers used to term bad checks.
Essentially, customers are told to ignore their check registers. Instead, they are invited to write a bad check and told the bank will cover it. The cost of this suckers bet typically $30 an item and $5 a day is buried in the blizzard of disclosures and paperwork given to the customer.
To maximize the income generated by this practice, banks exhaust the small available balance by posting the largest items first. The consultants watch gleefully as the volume of overdrafts (and their contingent fee for the advice) grows.
The consultants reasoning is simple. Why wait for the intermittent overdraft when you can entice weak-willed customers into writing checks for more than they have in their accounts?
Apparently, the income from conventional protection plans is now inadequate. Greed aside, the reason why is unclear. My sense is that the more traditional protections against ruining a reputation with an accidental overdraft require Regulation Z disclosure. However, the new variety of overdraft protection charges fees so large a banker is challenged to calculate the annual percentage rate, let alone disclose it.
Frankly, such practices are shameful. They represent psychographic analysis used in all the wrong ways and for all the wrong reasons. These dubious approaches do nothing to build the deep and lasting relationships that the industry professes to cherish: multiple product-and-service users of all stripes who look to their bankers for transaction processing, loan and investment products, and lifelong financial advice.
And it is not as if the industry doesnt know better. On the contrary, the trail of litigation and costly settlements paid by banks over overdraft practices goes back to the early 1970s. More recently, Bank of America Corp. settled a class action over posting schemes by its Boatmens Bancshares. In past instances, the only winners were the lawyers with their 40% contingent fees.
Yet despite the negative public relations these practices generate and the opportunities they create for class-action barracuda among trial lawyers, the industry continues to risk further confrontation by exploiting opportunities to generate more fee income from overdrafts.
Though disclosure might be difficult, it isnt the heart of the issue. The complaint about predatory lending is not about noncompliance with Reg Z or annual-percentage-rate calculation errors. It is that the practice intentionally targets people who cant help themselves, who do not fully understand what they are agreeing to until it is too late and foreclosure is inevitable.
Wrapping a predatory practice in the cloak of customer service is tantamount to arguing that the onerous terms of a predatory mortgage are the borrowers only chance at homeownership. Its hogwash.
In all but name, most of what occurs with Overdraft Courtesy is no more a service than payday lending a truly deceitful term and a worse practice. This and its evil cousin, check-cashing stores, target folks too uninformed, too careless, or with too few resources to make real choices. These practices amount to bankers playing kick the kid with one shoe.
Are these lines of business that a bank should covet? Is this how bankers, with a community service charge built right in to their corporate charters, want to be perceived? I can see Mike Wallace and the 60 Minutes editorial team planning their next expose now.
Reliance on overdraft fees to increase noninterest income is a bad idea and certainly not a credible strategy. These fees are an addiction that will end up haunting the banking industry.
Now would be an excellent time to stop kidding ourselves that these practices are a legitimate banking service. We need to return to treating overdrafts as financial mismanagement and loss risk. That is, as something we are obliged to discourage.
Mr. McGrath is a managing partner of Bank Earnings International LLP, a consulting firm in Orange, Va.
