Banks finally appear ready to turn the corner on how they view overdrafts — and the change of direction could help not only the industry's public image, but also the bottom line.
The new tack comes in many flavors. Some banks have decided that, instead of using them to gouge customers, the overdraft system can be a tool to reach the unbanked. Others haven't lowered the price of an overdraft, but are doing a better job explaining their fee schedules. At least one institution has decided to kill overdrafts altogether.
It took years of legal battles, arm-twisting by consumer advocacy groups and financial penalties from regulators. But banks now see overdrafts as a way to both develop future customers and serve the greater good.
"When the issue of banking access was posited as only a humanitarian issue, for banks it became more a question of charity, PR and that uncomfortable place outside of commercial sustainability," said Jonathan Mintz, director of the Cities for Financial Empowerment Fund.
Skeptics point out banks have ulterior motives. One is the upcoming proposed rules from the Consumer Financial Protection Bureau. Lynn David of Community Bank Consulting Services, in a Jan. 5 BankThinkcolumn, predicted the CFPB may crack down hard on overdrafts.
Another is dwindling fee income from overdrafts, a trend reported by numerous regional and community banks.
"Overdraft borrowings are well below our expectations," Geoffrey Hesslink, chief executive of the $2 billion-asset Merchants Bank in South Burlington, Vt., said during a July conference call. "The revenue miss there has been significant and material, frankly, to our earnings."
Even so, Mintz said enough banks have taken the right approach that he's optimistic about the direction for overdrafts in 2016.
"Seeing the market match the humanitarian equation is the hallmark of what 2015 has been to the banking access movement," Mintz said.
JPMorgan Chase and Bank of America in 2015 both adopted the safe account products standards developed by implementing the Cities for Financial Empowerment, called Bank On 2.0. Citigroup introduced its safe account product, Access, in 2014. Wells Fargo is expected to introduce in June its own safe account product.
The Bank On standards require an initial deposit of no more than $25; a $5 cap on monthly maintenance fees; and a limit on out-of-network ATM charges to $2.50 per transaction.
More institutions will introduce similar products this year, Mintz said. There also may be existing products that have not yet been brought to Mintz's attention.
"We expect that there are already some regional and local financial institutions — banks and credit unions, both — who offer accounts that meet or almost meet [the] Bank On account standards," he said.
Regional and community banks have also set the stage for a big push into the expansion of financial access. The $7.6 billion-asset Customers Bancorp in Wyomissing, Pa., established an online-banking subsidiary, BankMobile, that eschews fees for typical retail banking transactions.
"In 2016 we’re going to find a profitable way to reach out and offer banking services to millions of so-called unbanked in 2016," said Jay Sidhu, chairman and chief executive of Customers.
Other companies, including the $107 billion-asset Ally Financial in Detroit, have also developed business plans premised on charging lower fees for overdrafts. Ally charges $25 for one overdraft and caps the number of overdrafts to one per day. Ally also adopted the Pew Charitable Trusts' guidelines for a clear and concise explanation of all fees.
Of banks that still use overdrafts, some have eliminated a tactic that stuck in the craw of both consumers and regulators — transaction reordering. About 56% of banks surveyed by the Pew Charitable Trusts last year do not reorder the processing of transactions or charge an overdraft fee. That's up from 47% in 2014 and 41% in 2013.
Banks have also cut back on filing reports with credit bureaus that could hurt consumers. Capital One Financial in 2014 said it would limit the use of the ChexSystems customer-screening database that prevented many low-income consumers from opening accounts. Citigroup in January 2015 followed suit on its use of ChexSystems.
In spite of the progress, many other obstacles remain. One is the issue of short-term loans.
"There is limited appetite to create lower cost borrowing solutions — and that is the true gateway product for these consumers," said Nick Clements, co-founder of MagnifyMoney, a comparison-shopping site for consumer financial products.
"Until you solve the borrowing problem, you are not offering a real solution," Clements said.
It's not like banks haven't tried. Both the $124 billion-asset Regions Financial in Birmingham, Ala., and the $139 billion-asset Fifth Third Bancorp in Cincinnati offered deposit-advance loans until regulators cracked down. Regions discontinued its product, while Fifth Third made extensive changes, such as cutting the consumer's cost of borrowing, putting a serious dent in the product's profit.
The latest iterations of the overdraft concept, based on safe account standards, don't address short-term credit issue, Clement said.
"Most of these products look alike and do not have borrowing functionality," he said. "Banks want to offer products without overdraft fees without hurting the overdraft fee revenue line item."
That's because overdraft fees remain a staple of noninterest income at many banks. The $20 billion-asset TCF Financial in Wayzata, Minn., generated about $82 million in overdraft-related services through Nov. 5, making up about 9% of its operating revenue. TCF was also notified in the fall that the CFPB is examining its overdraft opt-in practices.
Overdrafts are also a major contributor to noninterest income at the $260 billion-asset TD Bank, the $4.5 billion-asset Woodforest National Bank in Houston and Regions Bank.
It's a source of revenue that banks don't want to concede, Clements said.
"The revenue remains critically important to retail banks," Clements said. "If I had to predict 12 months from now, I don’t think we will see any dramatic difference in the pricing of overdraft products from traditional banks."
That revenue source is shrinking, however. Numerous banks have reported a steady decline in overdraft fee income over the past several quarters.
"We've been experiencing a compression on service charges, particularly overdraft fees for such a long time," Phil Wenger, chairman and CEO of the $18 billion-asset Fulton Financial in Lancaster, Pa., said during a July conference call.
The solution may come by figuring out a way to offer short-term credit to consumers, while at the same time appeasing regulators. Overdrafts are "one of the lasting viable sources of short-term liquidity for many U.S. consumers," David Pommerehn, senior counsel at the Consumer Bankers Association, wrote in a Nov. 15 BankThink column.
Ultimately, consumer advocates hope that the CFPB will require banks treat overdrafts with the same type of credit analysis and risk management as they would for any other loan. Otherwise, overdrafts in their current form, remain a type of predatory lending, said Susan Weinstock, director consumer banking project at the Pew Charitable Trusts.
"Most people get direct deposit and will get another paycheck in the next week to a month," she said. "The risk to the bank of offering overdraft is pretty low and yet $35 is a very expensive form of credit."