Overdraft Rule from Fed Called Underdone

WASHINGTON — The Federal Reserve Board released an overdraft rule Thursday that would force banks to get customers' permission before enrolling them in such programs — but it did little to satisfy lawmakers who want to go even further.

While top leaders of the House and Senate banking committees have pushed bills that would require customers to opt in to overdraft protection, they are also seeking other restrictions, including monthly and yearly limits.

"We need to do far more to protect customers from abusive bank products," said Senate Banking Committee Chairman Chris Dodd, who has scheduled a hearing Tuesday on the issue. "We still need to stop the excessive fees, repeated charges, lax notification and processing manipulation that have become standard in these so-called overdraft 'protection' programs."

The sentiment reflected the deep unpopularity of the Fed in Congress, even as it goes further to protect consumers than it has in decades.

The overdraft rule goes into effect on July 1 and covers transactions conducted at automated teller machines as well as one-time debit card transactions. Banks would be prohibited from offering different terms or conditions on accounts for customers who decide to forgo the program. Additionally, customers who decide to take advantage of overdraft protection services can still decide to reject the coverage at any point.

Bankers, arguing that overdraft protection is actually a service for its customers, had pressed the Fed to embrace a rule that would let them instead give customers a chance to opt out of such coverage, betting that would have resulted in fewer accounts without protection. Industry representatives acknowledged their disappointment Thursday with the Fed rule, but seemed ready to move on.

"In the end, we could live with it," said Scott Talbott, a senior vice president with the Financial Services Roundtable.

That is likely because bills circulating on Capitol Hill could be far worse for the industry.

Proposals in the House and Senate would require that fees be proportional to the cost a bank incurs during an overdraft. They would also bar banks from imposing an overdraft more than once a month and six times a year.

Under the proposals, customers would see a prompt on the screen of their ATM alerting them that their transaction could result in an overdraft, and banks could not manipulate the order of clearing checks in a way that can rack up fees.

(The Fed issued Thursday's rule under Regulation E, which governs electronic fund transfers and does not have the scope to address check-clearing manipulation.)

The proposals have powerful sponsors, including House Financial Services Committee Chairman Barney Frank of Massachusetts, Rep. Carolyn Maloney, D-N.Y., Dodd and Sen. Charles Schumer, D-N.Y.

"The Hill doesn't give people a choice," said Nessa Feddis, a senior federal counsel for the American Bankers Association. "The bills don't seem to reflect the very well-documented consumer preference for having overdrafts paid for particularly important things like mortgages and bills. That would mean they would be less consumer-friendly."

Overdraft fees have become the subject of heated debate during the financial crisis. The Fed received more than 20,000 comment letters on an overdraft proposal it released in January. Banks say they offer the protection to save customers from embarrassment at the cash register. Consumer advocates counter that the fees are often unreasonable, especially when the overdraft was caused by a relatively small purchase.

In this fight, the Fed appeared to side with consumers. "The final overdraft rules represent an important step forward in consumer protection," Chairman Ben Bernanke said in a press release.

The Fed's move amounted to the latest attack on fees levied by banks. The House passed legislation this month that would immediately enact credit card reforms to go into effect in February. The card reform President Obama signed in May would, among other things, restrict fees and interest rate increases.

"Consumers are willing to pay reasonable fees for appropriate services," said David Berenbaum, the executive vice president of the National Community Reinvestment Coalition. "But there needs to be a rationality to the fee structure."

Overdraft fees do not disappear under the Fed's rule. Penalties can still be charged on a range of transactions, including checks and recurring debit card purchases. Fed officials speaking to reporters on Thursday said they did not extend the opt-in provision to these transactions because customers generally use these methods to pay for important, big-ticket items like rent or mortgages, along with utility bills.

Even though that means banks can still earn some income from fees, industry representatives are worried about the practical implications the Fed's differentiation could cause. At the moment, most banks' computer systems cannot distinguish between a $3 transaction at Starbucks and a $100 monthly fee for a health club membership.

"Some institutions can't make that differentiation at this time," said Steve Zeisel, the vice president and senior counsel at the Consumer Bankers Association. "Even differentiating between debit and checks is difficult. I think smaller institutions in particular may be impacted by that."

Though the rule is likely to cut into bank profits in this area — Fed officials estimated the industry makes $25 billion to $38 billion off of overdraft fees — industry representatives said they will find ways to protect themselves from habitual overdrafters and continue to make money.

Feddis of the ABA raised the possibility that banks may reverse the trend of offering free checking accounts and instead require customers to maintain a minimum balance to avoid fees.

"At the end of the day, income has to exceed expenses for any business model to succeed," Feddis said. "There may be less income, so there's going to be pressure."

Lawmakers, meanwhile, are poised to press ahead. Maloney said that the Fed rule does not "eliminate the need for congressional action."

"The Fed still allows institutions to charge an unlimited quantity of overdraft fees, would do nothing to make fees proportional to the amount of the overdraft, and would not address the manipulation of posting order of charges to accounts," she said in a statement.

Schumer attempted to put some onus back on the central bank.

"I urge the Fed to add even more muscle to these rules by limiting the amount of overdraft fees that can be charged in a single month, and by preventing banks from reordering charges to maximize profits," he said. "We will continue to do everything we can in the Senate to pass legislation to make this happen, whether the Fed acts or not."