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Understanding Overdraft Programs (Part 2): A New Approach to Overdraft

In our previous blog post I examined the shifting regulatory landscape, recent changes in bank overdraft program changes, and what’s next with regulations on overdraft. There has been a burst of activity introducing new approaches to courtesy overdraft. In this, my second post on overdraft, I will explore new approaches banks should consider.

Consider the following setting. Cue the dramatic music and the lights. You are about to pitch a new capability that will address the need for short-term liquidity for nearly half of US consumers. You have honed your pitch and you stride forward to present your concept to a panel of experienced innovators, investors and industry experts looking to discover a promising, fast growth solution. Wait, we don’t do this in banking? Banking is highly regulated and introducing a new and innovative service is often a slow process. Delivering a new solution as an alternative to overdraft may arrive faster than previous new service introductions within retail banking.

Within bank chartered financial institutions, new product introductions are cautiously considered and for the most part are incremental improvements within existing financial services. That is certainly true within deposits and the related services attached to these accounts. One of these services, courtesy overdraft is on the verge of a major transformation. Customers are expressing their dislike of overdraft fees and competitors are delivering solutions with improved transparency and customer experience. The conditions are ripe for change.

A savvy investor will demand to know how big the addressable market for your product is. When it comes to addressing short-term liquidity, the market size is likely 40%-50% of all consumers. Your investor panel looks up from their notepads after hearing this. Consider the following question, “How do you define the market size?”

Gartner classifies “financially vulnerable” as 40% of retail banking customers. Gartner’s classification is comprised from CFPB financial well-being scores.  Forrester has created a segmentation aligned to financial well-being. Customers who feel anxious about their financial situation and those who live paycheck to paycheck represent 51% of consumers.

At this point maybe our investor panel illustration needs an adjustment. The reality for banks looking to meet customer needs to smooth the lumps in their cash flow is not a single solution, but it could be multiple solutions. We will now examine a few options that will deliver more customer choice, enabling consumers to better manage their finances and assist with cashflow.

Show me The Solutions!

Allowing a deposit debit to clear when there are insufficient funds is the value of using courtesy overdraft. Banks looking to continue to offer this capability for a fee can consider a decision engine approach that can support one or more techniques. Banks can choose to assess a fee immediately (the current state) or within a defined period of time (i.e. post grace period). However, should the fee be the same for all transaction values? Proportional fee assessment can charge a fee that would increase at designated transaction amounts. If your customer wants to always pay a certain transaction such as the ACH for their power bill, you can provide a service that provides a level of customer control to automate this choice to ensure that this payment is paid when an account has insufficient funds.

Possibly your investor panel would like to hear about solutions that align to small dollar credit. They have seen the popularity of Buy Now Pay Later (BNPL). 90% BNPL purchases by GenZ consumers are $500 or less. BNPL is akin to a small dollar loan. A bank has a variety of small dollar credit options and many of these approaches can reach a broader audience than a bank’s current overdraft opt-in audience which often is around 18%-23% of checking account holders. A dedicated “lifeline” in the form of a line of credit or single use term loan are viable options. While linking a DDA to a credit card’s cash line is an established overdraft protection technique, many consumers choose a different bank for a credit card, they may not qualify for a credit card or simply prefer to not have a credit card. Alternative credit offerings such as these can reach upwards of 50% of your DDA account holders seeking to smooth out the lumps in their cashflow or provide peace of mind with a level of protection. Naturally, your investor panel will pepper you with questions ranging from credit-risk concerns to revenue generation. Leveraging a partner like FICO you can address these questions and provide a strong business case.

One of your investors asked you about the customer experience journey. “Customers want control, and no vague or confusing fees. You have any solutions to give customers more control?” Banks have been offering varying amounts of grace time before an overdraft fee is assessed. Giving customers more control at the transaction level for slower to post items including checks and ACH is a new approach, but the amount of time that can be extended is limited. Banks can offer the ability to delay a payment that has been deemed eligible (that’s where decision management comes in) within constraints of NACHA and Check21 standards. Allowing consumer to return an item when there are insufficient funds is a novel approach but can result in fees from the merchant. If your opted-out customers had the option to select eligible transactions for a one-time overdraft or extension of small dollar credit banks can reach a larger audience than those who have opted-in to courtesy overdraft protection.

Choosing a Solution that meets Customer Needs

Naturally, you real “investors” are senior stakeholders of the bank. The goals of a bank are not the same as an investor on Shark Tank. Bankers need to find the balance of delivering customer focused solutions within regulatory and credit-risk constraints while delivering positive returns for shareholders. It is actually much harder than a “nimble startup” but the rewards can be outstanding. FICO’s research indicates 86% of consumers are satisfied with their bank. However, only a small percentage of customers feel that their banks are delivering services to improve their financial wellbeing. The question for banks is not, “Can I deliver alternatives to overdraft” but “Which services should I deliver?”

At FICO enabling these solutions and more are at the heart of our capabilities. If you are starting this journey, we recommend you consider your credit-risk position regarding small dollar credit and if this aligns to your strategy. Examine your technology and determine the gaps in existing capabilities and consider how a modern decision management approach can be leveraged to power one or more solutions.

Contact FICO to learn more about solutions and how to get started on this journey. Visit us at https://www.fico.com/en/industries/deposits.

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