Financial institutions rake in billions annually from overdraft fees. Some banks and credit unions recently have curbed or ended these fees for their customers — for which they should be commended — but many more depository institutions quietly continue overdraft practices that, at their best, nickel-and-dime consumers and, at their worst, cause devastating, lasting harm to financially vulnerable families.
Overdraft charges are too important to the bottom line to expect that urging these institutions to "do the right thing" will suffice.
This is a systemic problem that requires strong action. Financial regulators must rein in the size and frequency of these fees. We need our government to stop financial institutions from fleecing consumers with overdraft fees.
Consider the experience of Stacy, a single mother of three in Connecticut, who has paid more than a thousand dollars in overdraft fees. Getting repeatedly slammed with fees while working at a low-paying retail job, she wrote, "… I still hear my son complain and moan of hunger, and I feel guilty yet defenseless because the money is gone."
A financial institution charges an overdraft fee when a person does not have enough money "available" in their checking account to cover incoming purchases. This levy, typically $35 for each overdraft, is, as Stacy put it, "a momentous amount for a low-income family."
The size of the fee bears no relation to the minimal cost to financial institutions of covering the overdraft.
Avoiding a fee can be tricky because the timing and order of deposits and payments hitting a consumer's account is opaque. Some depositories have manipulated that order to trigger multiple overdraft fees.
Another practice that depositories have deployed is charging an additional overdraft fee when their customer does not bring the account balance back to positive within a set time frame. These "sustained" overdraft fees are tantamount to kicking a person when they're down.
Overdraft practices are pushing families to the margins of the banking system — or out of it altogether. Nine percent of account holders overdraw their accounts more than ten times annually, getting relentlessly hammered with fees. The median account balance of this hard-hit group is less than $350. Furthermore, Black and Latino checking account holders disproportionately incur this charge. These fees are a leading cause of banks closing a consumer's account; for these consumers, reentry into the banking system is often exceedingly difficult.
How did this problem arise and how can it be addressed?
In the 1990s, financial institutions started broadly allowing customers to overdraw while charging a sizable fee. By the 2000s, this practice had spread nationwide.
Depositories extended the fee to debit cards, which — unlike credit cards — were not designed to put consumers in debt. Debit card transactions became the most common trigger of overdraft charges. People have ended up paying $40 or more for everyday items like milk because of overdraft fees on debit cards.
The Federal Reserve in 2009 announced a modest rule requiring a consumer's one-time consent to allow overdraft on ATM or debit card transactions. This "opt-in" rule has helped, but it has fallen far short of what is needed.
Research by the Consumer Financial Protection Bureau found that, even with this rule, a "significant segment of consumers" pays substantial sums, and even people with "more moderate overdraft use" may pay hundreds of dollars in overdraft fees annually.
The fundamental problems with these fees remain unaddressed: they cost too much and are charged too frequently. This is a license for profiteering, epitomized by a former bank CEO who named his boat Overdraft.
Some financial institutions are overdraft fee mills. In 2019 and 2020, Woodforest National Bank, First Convenience Bank and Academy Bank each had more overdraft revenue than profit. Hundreds of Walmart stores house these banks' branches, which threaten Walmart customers' financial stability.
It is misguided to believe consumers inevitably will switch to institutions with better overdraft practices. This ignores the difficulty of changing banks, especially for low-income consumers, and that people don't shop for a bank based on surprise charges.
Moreover, the explosive growth of fintech loans that can trigger overdrafts, including "buy now, pay later," shows how without common sense regulation, technological changes can aggravate this problem.
Federal bank and credit union regulators — the CFPB, Office of the Comptroller of the Currency, Federal Reserve Board, National Credit Union Administration and Federal Deposit Insurance Corp. — have a responsibility to protect consumers and ensure financial institutions' safety and soundness. They must address the harm overdraft fees inflict on consumers and the risk posed by financial institutions' overreliance on them.
In recent months, the CFPB has published high-profile research, heightened supervisory scrutiny, and — in a potential step toward administrative rulemaking — sought public input on overdraft fees. These moves mark important progress for consumers — but far more is needed.
Regulators can take several steps, including through a comprehensive rule, to rein in exploitative, high-cost overdraft fees. They could prohibit predatory posting practices, curtail the assessment of multiple overdraft fees during a single overdraft episode and require that the cost per fee be reasonable and be proportional to the cost incurred by the depository institution.
For depositories hooked on this fee income, these regulatory steps would encourage a more sustainable business model. For institutions inclined to reduce overdraft fees but afraid it would put them at a competitive disadvantage, this regulation would solve a collective action problem and level the playing field.
These steps would ensure that all consumers — regardless of where they bank — will have a baseline level of protection from abusive overdraft programs. This would increase consumer trust in banks and credit unions.
For families who are impoverished, or have fallen on tough times, this regulation would prevent overdraft fees from pulling them much deeper into the hole and make it easier for them to climb out. This is also in the self-interest of financial institutions, which benefit when their customers advance financially.
It is time for regulators to act. As we've seen before, letting banks police themselves won't work.
