Overdraft Programs: Balancing Risk vs. Reward
One thing that came out of the financial crisis that started in 2007 in the United States was the government concluding that consumers needed more protection from the financial industry. President Obama proposed a new financial agency that would focus on consumers instead of on bank safety and soundness or monetary policy. The Consumer Financial Protection Bureau (CFPB) was born in 2010 as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act. One of the CFPB’s main focuses, since its inception, has been fees charged to consumers. One type of fee that has always been on the CFPB’s radar is the overdraft fee. Regulators are looking at overdraft programs as they pertain to specific regulations such as Regulation DD, Regulation E, and Unfair or Deceptive Acts or Practices (UDAP), and the expanded Unfair, Deceptive, or Abusive Acts or Practices (UDAAP). It is crucial for banks to minimize their risks associated with overdraft products.
The FDIC supervisory guidance issued in December 2010 (FIL-81-2010) highlights the following actions that banks should take to mitigate safety and soundness as well as compliance risks associated with overdraft programs:
- Ensure that the board of directors provides appropriate oversight of the programs, including an annual review of the overdraft program.
- Review through internal or external audits all marketing pieces, disclosures, and the overall implementation of the overdraft program. The goal is to ensure minimization of any potential customer confusion and at the same time promote responsible use of the program.
- Train all staff on how to appropriately explain the program features and any other choices available.
- Prominently distinguish account balances from any available overdraft coverage amounts. Regulation DD prohibits banks from including overdraft coverage amounts in any balances provided by an automated system such as ATMs.
- Monitor for excessive customer use, and offer customers less costly options if excessive use does occur.
- Consider daily overdraft fee limits.
- Consider eliminating overdraft fees for transactions that overdraw an account by less than a de minimis amount.
Six years after the formation of the CFPB and the issuance of supervisory guidance by the FDIC, overdraft programs continue to be a common focus of regulatory examinations. To help monitor the amount of overdraft-related fees collected by banks, starting in 2015, banks with more than $1 billion in assets are required to report fee income from overdraft and nonsufficient funds (NSF) fees as part of their call reports. The CFPB reported that at the end of 2015, consumer overdraft and NSF fees totaled $11.6 billion in revenue. This number accounted for approximately 8.0% of the reporting banks’ total net income and 65.3% of all reported consumer deposit account fee revenues. The CFPB plans to analyze this data to be able to more effectively monitor overdraft programs and better protect the consumer.
One of the main focuses of the FDIC is that banks prove they are providing “meaningful and effective” follow-up to their customers whose use of overdraft protection programs becomes chronic or excessive. In other words, the FDIC wants to see that the banks have attempted to provide less costly alternatives to these customers. Banks can contact customers via telephone, in person, by mail, or even through electronic notifications. In addition, banks should be able to show that they monitor overdrafts and address any chronic or excessive use. Finally, as noted in the 2010 FDIC guidance, the FDIC encourages banks to allow customers the option to decline overdraft coverage (opt-out) for transactions not subject to Regulation E requirements.
In conclusion, there are several things that banks can do to avoid adverse regulatory scrutiny regarding overdraft programs.
- First, monitoring of overdraft programs should be a standard part of any compliance management program.
- Second, as a result of monitoring, management should analyze the fee income generated by the overdraft programs and determine whether it is reasonable or unfair to customers.
- Finally, banks should follow-up with their customers when use of overdraft programs becomes excessive or chronic.
Overdraft program benefits can be twofold; they can serve as a valuable tool to customers and can also serve as a revenue stream for banks. The programs just have to be designed so that the rewards and the risks are in balance.