The Consumer Financial Protection Bureau (CFPB) released a report today on bank and credit union overdraft practices that raises concerns about whether the overdraft costs on consumer checking accounts can be anticipated and avoided.
The report shows big differences across financial institutions when it comes to overdraft coverage on debit card transactions and ATM withdrawals, drawing into question how banks sell this account feature. The report also finds that consumers who opt in for overdraft coverage end up with more costs and more involuntary account closures.
“Consumers need to be able to anticipate and avoid unnecessary fees on their checking accounts. But we are concerned that overdraft programs at some banks may be increasing consumer costs,” said CFPB Director Richard Cordray. “What is often marketed as overdraft protection may actually be putting consumers at greater risk of harm.”
The overdraft report is available at: http://files.consumerfinance.gov/f/201306_cfpb_whitepaper_overdraft-practices.pdf
The report was hailed by the National Consumer Law Center.
“The consumers who pay the most overdraft fees are also the most economically vulnerable,” said National Consumer Law Center staff attorney Chi Chi Wu, “So the fattest profits of some of the biggest banks are being made off the backs of those least able to afford it.”
While the CFPB report does not include information about processing and administrative costs, NCLC recently issued a report “Common Sense from the Common Law” estimating that such costs range from 54 cents to $3.50. “Fourteen percent of $35 is only about $5,” calculated report author Wu, “Even assuming the higher estimate for processing, it means the average big bank makes over $25 in pure profit from each overdraft fee.”
Some of the reforms urged by NCLC advocates include:
- Limiting the number of times consumers can overdraw their accounts and be charged an overdraft fee to six times per year.
- Prohibiting point-of-sale debit and ATM card overdrafts, given that these transactions can be declined in real time without a fee.
- Requiring that overdraft fees be “reasonable and proportional” to the cost incurred by the banks for overdrawn or not sufficient funds transactions.
- Prohibiting banks from posting transactions from highest to lowest in amount, or in any manner that increases the number of overdrafts, and instead requiring that banks post transactions to minimize fees, or at least in a chronological or other neutral order
- Requiring banks to provide Truth in Lending disclosures, given that overdrafts actually represent a form of very high cost credit.
An overdraft can occur when consumers spend or withdraw more money from their checking accounts than is available. The financial institution can choose to cover the payment by advancing funds on the consumer’s behalf, and generally charges a fixed overdraft fee for doing so. The institution can also choose to return the payment if it is a check, online bill payment, or direct debit, and then charge a non-sufficient fund fee. In recent years, most banks have adopted automated systems for making these decisions. These systems have contributed to the evolution of overdraft from an occasional courtesy to a significant source of industry revenues. The CFPB estimates that overdraft and non-sufficient fund fees represent 60 percent or more of consumer checking account fee income.
The CFPB did this overdraft study, which reflects a significant portion of U.S. consumer checking accounts, after initial market research raised concerns about overdraft practices. The information in the study was largely gleaned from confidential information from a small set of large banks supervised by the CFPB. It was supplemented by responses to a CFPB Request for Information issued to the public in February 2012, and a recent study by the Independent Community Bankers of America.
Opting-in puts consumers at greater risk
In 2010, a new federal government regulation took effect requiring that banks and credit unions obtain a consumer’s consent before charging fees for allowing overdrafts on ATM withdrawals and most debit card transactions. Today’s CFPB study found that new customer opt-in rates varied across banks. At some banks in 2011, more than 40 percent of all new customers opted in while other banks saw only single digit opt-in rates. The study also found that a consumer’s decision to opt in may have significant ramifications:
- Consumers who opt in end up with more costs: The CFPB study looked at previous heavy overdrafters who declined to opt in when the new federal requirements were implemented in 2010. It found that by opting out these accountholders reduced their overdraft and non-sufficient fund fees, on average, by more than $450 in the second half of 2010.
- Consumers who opt in to overdraft are more likely to end up with involuntary account closures: Negative account balances are a significant contributor to involuntary account closures at many banks and credit unions. The CFPB study found that at some banks in the study involuntary closure rates were more than 2.5 times higher for accounts that had opted in to debit and ATM overdraft coverage.
Overdraft practices vary by institution
The CFPB study raises questions about whether overdraft costs can be anticipated and avoided. A bank’s complex and often unique overdraft policies, procedures, and practices can be very difficult for a consumer to understand. This is true for consumers who have opted in but also for those who have not but are trying to figure out their potential costs in using their bank’s services. These complexities include:
- Complex transaction postings: The order in which transactions are posted to an account can influence the number of transactions that incur an overdraft fee. The study found wide variation in posting practices, from institutions debiting transactions at periodic intervals throughout the day to debiting them in nightly batches. Banks also differ in how they combine, sort, or order the transactions.
- Overdraft coverage limits that often depend on many factors: The overdraft coverage limit is the amount of money the institution is willing to advance to an accountholder when his or her funds are insufficient to cover a pending payment. Some institutions have limits of fixed amounts, others vary limits based on the accountholder’s individual circumstances, such as his or her deposit patterns. Smaller limits reduce the opportunities for overdraft but can result in more non-sufficient fund fees. Higher limits can result in more overdraft fees because the consumer may keep drawing from his or her account.
- Complicated fee structures that are not standardized: Institutions have different fee structures when it comes to capping the number of overdrafts that can be incurred in a single day. Some banks, for example, limit the number of overdraft charges in a day to two; other banks have no cap on fees or caps that allow as many as 12 overdrafts and non-sufficient fund fees in a day. Similarly, some banks will not charge an overdraft fee for any item that overdraws the account by less than $5 while other banks charge fees on every overdraft transaction regardless of size.
Costs and closures vary by institution
Because bank and credit union overdraft policies, procedures, and practices are so different, the outcomes for consumers at the various banks in the study also varied. This raises questions about why some consumers are incurring much higher costs than others – especially when overdraft costs are not upfront fees but automated, back-end charges largely difficult for the consumer to predict. The CFPB study found:
- Average annual overdraft charges vary among institutions: The average consumer who overdrew his or her account paid $225 in overdraft and insufficient funds charges over the course of one year. Among the banks in the study, consumers at some banks paid an average of $298 while consumers at others paid only $147.
- Involuntary account closures vary widely: Among the banks in the study the rate of involuntary closures appears to have varied by nearly 9 percentage points across the banks in the study.
A factsheet about overdraft practices is available at: http://files.consumerfinance.gov/f/201306_cfpb_factsheet_overdraft-practices.pdf
In addition to the institution-level data reviewed in today’s report, the CFPB plans future studies of account-level data to better understand how differences in bank practices affect consumers. If the CFPB finds that policies or practices do not protect consumers in accordance with federal consumer protection law, it will use its authorities to provide such protection. The goal is to make checking accounts more fair, transparent, and competitive and to ensure consumers are empowered to take control over their economic lives.
The Consumer Financial Protection Bureau is a 21st century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives. For more information, visit consumerfinance.gov.