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Understanding Overdraft Programs (Part 1)

We all experience unexpected expenses such as medical bills, needing a new roof, and car repairs. Sometimes unexpected expenses hit all at once, or we haven’t put away enough in our rainy-day fund. This is where Overdraft (OD) programs come into play. Courtesy overdraft is a service offered with a deposit account to provide liquidity to a bank customer when their balance has insufficient funds to cover incoming payments from a debit card, ATM, check or an ACH (Automated Clearing House) payment. In the United States, a customer must opt-in to this service for debit and ATM card transactions (required by the 2010 update to Regulation E) and a flat fee is applied per the terms and conditions of the program offered by the bank.

With the change in the regulatory climate, overdraft programs have been drawing scrutiny, but the need remains for consumers. The concept of providing customers with an extension of funds is not going away, and the overdraft programs continue to evolve.

The use of overdraft services has been extensively researched by organizations such as the Pew Charitable Trusts, and the Consumer Financial Protection Bureau (CFPB). Researchers often cite the negative financial impact of fee-based overdraft on the most financially fragile consumers. Over the past few years, the fees generated, and usage of overdraft has been an ongoing debate, with concerns raised by both policy leaders in Congress as well as consumer advocacy organizations. Recently, a growing number of banking institutions have introduced changes to their overdraft programs including no longer charging fees to alternative ways to assist customers with their short-term cashflow needs.

In this first of two blog posts, I had an opportunity to chat with David Pommerehn, the General Counsel and Senior Vice President at the Consumer Bankers Association (CBA), an expert on the state of overdraft in the banking industry. Our discussion explored the shifting regulatory landscape, banks’ latest overdraft program changes, and what’s next with regulations on overdraft.  My second blog post will focus on solutions for banks to better serve their customers who need short-term liquidity.

Let’s begin with our discussion with CBA’s David Pommerehn.

FICO: Could you briefly explain the existing state of overdraft regulations (opt-in treatment of debit card/ATM vs. check/ACH)?

Mr. Pommerehn: Overdraft regulations have remained relatively unchanged since the opt-in provisions (Reg E) were implemented in 2010.  New leadership at the CFPB has indicated that OD is on the agenda for a possible rulemaking.  What that will look like, we do not know, but we do know the CFPB has been collecting data on OD practices for years and many of their concerns center around “chronic users” (those who overdraft 10 or more times a year) and the process of opt in as it pertains to consumer disclosure and transparency.  In 2014, the Bureau moved to recategorize overdraft on prepaid cards as a “credit feature” under regulation Z.  However, we do not believe that is the direction for deposit account overdraft. 

There are numerous enforcement actions under way as well as litigation related to overdraft.  All this is in addition to a legislative proposal by Rep. Carolyn Maloney (D-NY) that would severely curtail overdraft practices. 

FICO: Is there consensus within the industry that the existing regulations are sufficient?

Mr. Pommerehn: Yes, we believe that regulation E opt-in has been sufficient in giving consumers the choice to use overdraft or not.  Average opt-in rates hover around 20% and we believe consumers need to make their own informed choices.  Additionally, there are few viable options currently in the market that provide consumers with a financial cushion for emergencies.  Overdraft becomes a valuable service for those who find themselves in need of emergency funds. 

FICO: There is a lot of focus on the cost of overdraft coverage. Overdraft protection provides a benefit to the bank customers and the merchants they are paying but does comes with a risk that a customer cannot address their balance shortfall. In your opinion, is there an appreciation of the risks for banks in extending payment when insufficient funds exist?

Mr. Pommerehn: Of course. Debt cycles and charge offed accounts are always a concern.  Banks have implemented many ways for consumers to avoid overdraft, including de minimis exemptions, grace periods, low balance and OD alerts, and accounts that do not maintain the ability to overdraft at all.  For those that cannot sufficiently address a shortfall, there should be a discussion with their account provider and an examination of possible alternatives. 

FICO: Recently, a number of banks (led by Ally, PNC, TD and others) are reworking their overdraft strategies. What is driving this wave of changes? Do you expect other banks to implement similar changes even if this results in lower generated revenue?   

Mr. Pommerehn: The market is responding to consumer needs.  We believe depositories will continue to innovate in this space, giving consumers more flexibility while retaining options for those that decide to utilize them.  

FICO: Looking into your crystal ball, what, if any, policy changes do you expect regarding overdraft in the next year?

Mr. Pommerehn: It’s hard to say.  Again, many changes from the account providers themselves, will certainly happen, which may mitigate much of the desire to regulate/legislate in this space.  We expect the CFPB to continue its review of the service and a proposal could be made as early as the first half of 2022.  What that may look like is unknown, but possible “solutions” could be wide ranging.

Since our conversation, more and more banks have made statements on possible new services or changes to fees within the overdraft service category. In August of 2021 Jamie Dimon stated "A lot of competitors are making changes and we may be a day late and a dollar slow, but if it's appropriate, we're going to make a bunch of changes." Fintech offerings such as Chime’s “SpotMe” have illustrated a few possibilities to provide a short-term, small dollar liquidity service for consumers.

The push for new short-term liquidity solutions is definitely in full gear and I look forward to sharing my insights and suggestions on this important topic in my next post.

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