“The only easy day was yesterday” is a phrase that feels especially apt when contemplating current overdraft program trends. Competition from other financial institutions and fintechs coupled with regulatory agency guidance has resulted in a quandary for banks that are trying to do the “right thing” for their customers.
In the 1980s, banks and credit unions began accepting risk by paying items presented even when balances were insufficient. Now, fintechs seem to have decided consumers should not pay any deposit account related fees — and
Overdraft fees are frequently criticized as unfair to lower-income consumers, but it’s important to remember that they also protect consumers and facilitate commerce. If regulators truly want to be consumer-friendly, they should be monitoring how frequently transactions are returned — when checks bounce, in other words — because a returned item harms the entire payments channel, from consumer to bank to merchant.
And the recent trend away from overdraft fees comes at a time when banks are having a harder time finding income in other places. Noninterest income has declined to roughly 25% of the average financial institution’s revenue since the Durbin amendment cut debit card interchange income. That trend has hastened the decline of free checking, surely a consumer-friendly offering. If banks are no longer able to collect overdraft fees, what unintended consequences may result?
Certainly penalizing people for an honest mistake is bad business, but the bank is not the only party concerned. If banks simply refused payments that reflect insufficient funds, the consumer would likely be subject to returned-payment penalties from the merchant — fees that are frequently higher than overdraft fees. And in certain cases it is critical that transactions be completed — for utility bills or life-saving medication, for example — which is to say nothing of the impact that a returned payment can have on consumers’ credit scores.
Abandoning overdrafts hurts banks as well by further eroding noninterest income — of particular importance for small banks — and leading to charge-offs for delinquent payments. That could lead to more pressure on small banks’ branch networks to consolidate, an outcome that neither banks nor consumers would welcome.
Merchants would lose out if there were a strong regulatory push to curb overdraft fees. Returned payments are costly and cumbersome for merchants, particularly smaller vendors who lack the staff to handle a large volume of refused payments. A significant increase in payment returns could also compel merchants to offset the higher risk of returns with higher consumer prices.
The simple truth is that one size rarely fits all, and that’s as true for overdrafts as it is for any other regulatory proposal. Financial institutions have to decide for themselves how to complete transactions while considering a customer’s ability to pay, potential losses from fraud and theft and the prudential underwriting requirements that they must maintain.
With these realities in mind, there are important customer-friendly practices that banks can put into place that can ease the sting of overdraft fees. Banks can adjust how much they charge in overdraft fees, establish a daily maximum of fees they will charge, institute proactive balance alerts, make financial education readily available and more.
But above all, bankers should be wary of simple solutions, and unfortunately there are many out there already. A prominent one is Chime’s SpotMe, a free overdraft program that starts at a mere $20 with an electronic deposit. A consumer may qualify for up to $200, but the fine print specifies that SpotMe applies only to electronic items: no checks or ACH overdrafts. Financial institutions that are considering following Chime’s lead and no longer charging overdraft items would do well to consider what happens if you have to refuse payments instead.
The most critical goal for banks is to strive to pay items on behalf of customers as much as they can. Most banks and credit unions have much higher overdraft limits than Chime’s $200, and most flat limits are more than double Chime’s. So, what happens to these customers if limits decline as fee revenue vanishes? Bankers and consumers really don’t want to return to the days when all items were returned.
For an America that’s benefited from more than $5 trillion of stimulus money, news of waiving overdraft fees may sound like another big win for consumers. However, if a bank charges no fees, that doesn’t mean its customers pay no fee. New strategies aimed at reducing overdraft fees will result in several unintended consequences, many of which disproportionately harm small businesses and lower-income consumers.
Financial institutions have a lot of work ahead as they respond to these major shifts in retail banking and set a growth strategy for the future. Hoping these pressures will simply go away is unrealistic, and the sooner banks and regulators grapple with that reality, the better.
