Overdraft Is a Service in Need of Reform

Should the Consumer Financial Protection Bureau (CFPB) propose new rules aimed at making checking account overdraft policies at banks and other depository institutions safer and more transparent? Some banking industry representatives are questioning the need for CFPB action (“Consumers Lose if CFPB Overshoots on Overdraft,” BankThink, Nov. 10, 2015), but research by The Pew Charitable Trusts since 2010 has found that overdraft reforms are necessary—and that Americans support them.

Rules require that banks may not levy overdraft charges unless consumers provide fully informed consent in advance. Yet when Pew surveyed consumers, we found that more than half of those who incurred a debit card overdraft fee didn’t believe that they had opted in to overdraft coverage. And the costs add up quickly, as the CFPB has found and Pew’s research has borne out. Put in lending terms, if a consumer borrowed $24 for three days (the typical scenario with an overdraft) and paid the median overdraft fee of $34, such a loan would carry a 17,000 percent annual percentage rate (APR). “Overdrafters” in the Pew survey reported paying total fees averaging $69 during their most recent overdraft, with over half paying between $30 and $100. Moreover, similar to the CFPB’s findings, most had negative balances for four or fewer days, and the transaction that caused their overdraft was for $50 or less.

Pew also found that more than three-quarters of those who paid an overdraft fee voiced concern about specific overdraft policies—including the high cost (at big banks, typically $35 to $38 per transaction), the imposition of “extended” fees, and the still-too-prevalent practice of banks reordering transactions from high to low to maximize fee revenue. Most of the consumers we surveyed told us they would prefer to have their debit or ATM transaction declined rather than pay an overdraft penalty, and they said they support greater regulation of overdraft products. And when we recently examined the CFPB’s public Consumer Complaint Database, we discovered that nearly 1 in 4 bank account or service complaints described issues related to overdraft policies and fees.

In addition, our research shows that the financial burdens of overdrafts are not distributed evenly among Americans; they fall harder on younger, lower-income, and nonwhite account holders. The cumulative effect can, and does, push vulnerable people out of the banking system altogether. Our survey of debit card users who overdrew their checking accounts found that 13 percent of those who paid an overdraft penalty no longer have a checking account

Checking account overdrafts first began as a service to provide occasional support for consumers but today have become a major revenue generator for the industry. When Pew studied 42 of the 50 largest U.S. banks earlier this year, we found that those that allow ATM and point-of-sale debit overdrafts reported nearly 400 percent more revenue from overdraft fees than banks that do not—with overdraft fees surpassing $2.4 billion in just the first six months of 2015.

All of this evidence adds up to a need for significant change. Clear disclosure of the terms and conditions on bank overdraft policies would improve the situation. But in its coming rule-making, the CFPB needs to go further—because while disclosure is necessary to protect consumers, it is not sufficient. The CFPB should make overdraft penalties reasonable and proportional to the banks’ costs in covering the overdraft and should prohibit the practice of transaction reordering. The bureau’s policies—and those of prudential bank regulators—should also encourage financial institutions to offer affordable and sustainable small-dollar credit products. This approach would allow overdraft to return to what it was originally intended to be: an occasional service for a modest fee.

This article ran in the American Banker on December 3, 2015. Susan Weinstock directs the consumer banking project at The Pew Charitable Trusts.