Regulators Target Excessive Reliance on Overdraft
The heat is back on overdraft. Now that the Consumer Financial Protection Bureau (CFPB) and other regulatory agencies have finalized a number of enforcement actions against large credit card businesses, they are re-focusing attention on banks’ overdraft programs and practices, following similar investigations several years ago.
Many banks have anticipated this additional scrutiny and made substantial changes to their overdraft programs. Among these changes are limiting the number of overdraft charges per day, increasing the dollar threshold below which a charge will not be imposed, eliminating continuous (daily) overdraft fees on unpaid balances and increasing the frequency of customer notifications and communications. Some have eliminated their overdraft programs altogether or introduced new products that do not allow customers to overdraw their accounts.
One clear result of these changes has been a significant decline in overdraft fee income which, in turn, has contributed significantly to the 21% drop in deposit service charge income (a whopping $9 billion) for the industry since 2009. After all these changes, do the regulators think the industry has done enough? The answer to that question is a definitive no.
Historically, there have been a few banks that seemed to be more in the overdraft business than the banking business. These institutions developed programs, processes and practices designed to enable and encourage overdraft behavior and maximize fee income. Such strategies proved unsustainable and those banks either changed their practices or have gone out of business. Most banks now view overdrafts as a necessary customer accommodation, not a core part of their business models.
Let’s face it, managing overdraft programs can be costly, customer conversations awkward and the risks of writing off unpaid balances high and increasing. On the other hand, there are significant costs associated with allowing customers to overdraw their accounts. Moreover, many customers want and value the service. It can be easily shown that returning a check unpaid can cost the customer two to three times the amount of an overdraft fee, even if the bank does not charge for returning the check. Add in the damage of a bounced check to the customer’s reputation, and the value of paying an overdraft only increases. The industry, quite rightly, believes that banks should be able to charge for this value and recoup at least part of their costs. Seems like a pretty good argument, right? A number of consumer groups and many of our regulators disagree.
While it is unlikely that overdraft services and programs will disappear entirely, there is no question that managing, monitoring and administering these programs will become more difficult and more costly. Regulators are shifting their focus from trying to eliminate these services to a greater emphasis on transparency and proactive customer management.
Over the last few years, many banks have made great strides on that front by simplifying disclosures and providing more and better information regarding costs and benefits of the various options. Helping the customer make more informed decisions is not only good from a regulatory perspective but benefits both consumers and the bank. These efforts will, and should, continue.
The more difficult challenge is trying to comply with a perspective that seems to mandate that banks take extraordinary steps to protect customers from themselves once they have made an informed choice on how they want to handle overdraft coverage. The regulatory focus is increasingly on what is called “excessive reliance,” or identifying those customers who make extensive use of overdraft services and proactively taking measures to stop that behavior. An emerging issue is “fairness,” which translates into monitoring programs to make sure all customers are treated equally. The two are connected.
The concept of “excessive reliance,” understandably, is confusing to many bankers. While the FDIC issued some guidance in 2005 and clarified that guidance further in 2010, setting forth recommendations on when and how banks should notify customers of overdraft occurrences and options to avoid further charges, these guidelines were never adopted by other agencies nor made part of regulatory examinations. In fact, there still are no hard and fast rules on what constitutes “excessive reliance,” yet many banks are facing regulatory criticism and potential fines based on amorphous and changing criteria.
There is no question that “excessive” is a relative concept. Ten overdrafts in one year may be excessive for one customer, but fifty in one year may be the result of a rational choice by another. For years, banks have looked at this issue on a customer-by-customer basis from a credit perspective. The decision to pay or not pay an item, place an account on return-all status or close an account was a credit judgment based on an understanding of the customer’s account history and individual situation. In most cases, these credit decisions were based on sound analysis and criteria.
It is likely that much of this discretion will disappear and be replaced by rigorous metrics that determine when a customer is contacted by the bank, overdraft privileges revoked or accounts closed. Importantly, monitoring systems will have to be developed and implemented that track this activity to prove that decisions are made consistently within these established parameters. Unfortunately, there is a very real chance that some individual customers will be harmed in an attempt to be “fair” to all consumers. This creates a dilemma for bankers. Pay an item or keep an account open and you may be accused of enabling and encouraging inappropriate behavior. Return an item or close an account and you may damage a long term customer relationship.
The concepts of fairness and consistency are not only being applied to item payment and account closure decisions, but are now bleeding over to ancillary decisions such as fee waivers. In our experience, non-sufficient funds (NSF) fee waivers at most banks normally run between 5% and 10% of fees charged. Most often, customer-facing personnel are given the authority and are empowered to make these decisions either based on an understanding of the customer’s relationship or through customer conversations. Some banks, but certainly not all, have strict parameters that determine whether or not a customer qualifies for, or is entitled to, a fee waiver.
However, more and more compliance departments are starting to look at fee waivers through the same lens they use for fair lending and are becoming concerned about the potential for disparate impact when individual employees are allowed to make these types of decisions. While this seems to be a bit of a stretch to apply fair lending concepts to fee waivers, the reality is that many banks will be forced to create more rigorous systems that mandate when and if a fee should be waived and to track and justify exceptions at the account level. The result will be higher costs, greater customer dissatisfaction and continued movement of customer relationship management decisions away from the employees who know the customers best.
While it is difficult to prepare for this more rigorous scrutiny when expectations are unclear, guidelines are relative and regulatory perspectives are hard to discern, preparation is necessary, nonetheless. This preparation includes analyzing objectively current overdraft programs and practices; assessing the regulatory and compliance risks associated with those programs; defining options for changes that align with the company’s operating philosophy and business model; establishing appropriate monitoring benchmarks and metrics; and developing actionable implementation plans.
Moreover, this preparation requires a strong partnership between the business unit and compliance department to strike the proper balance between regulatory expectations and customer relationship management. Banks that take these steps proactively will not only protect themselves from regulatory actions but will have a much better chance of creating viable and sustainable overdraft programs that both benefit their customers and protect the bank.