Rethinking overdraft

Jul 12, 2021
In The News

A pair of congressional hearings on Capitol Hill in May served as a perfect setting for Democrats and Republicans to take shots at Wall Street’s most powerful bank CEOs.

While some Republicans focused their questioning around voting rights and "woke-ism," several Democrats took aim at the overdraft fee — a charge financial institutions levy on their customers when they overdraw their accounts. 

Sen. Elizabeth Warren, D-MA, wasted no time calling out Jamie Dimon, the CEO of the nation’s largest bank, JPMorgan Chase, as "the star of the overdraft show" for the $1.5 billion in overdraft fees the bank collected during the COVID-19 crisis. 

A testy exchange followed, where Dimon called Warren’s numbers "totally inaccurate." But the stage was already set. The senator dismissed — as "a bunch of baloney" —  the bank’s claims that it stepped up efforts to help customers amid the pandemic. Warren, rather, pointed to the $27.6 billion in profits JPMorgan made during a period that saw record unemployment. 

While the bank responded to Warren’s criticism by saying it waived more than $430 million in overdraft fees at customers’ requests between January 2020 and March 2021, the senator managed to shine a spotlight on JPMorgan, which collected more in overdraft fees than any other bank in the U.S. 

Although the fees made large banks the targets of lawmakers’ scrutiny, it’s the nation's community banks that were most reliant on service charges for operating revenue last year. 

A pair of Texas-based banks, First National Bank Texas and Woodforest National Bank, booked service charges that accounted for more than 30% of their operating revenue in 2020, according to data from S&P Global

Killeen, Texas-based First National reported $100.3 million in overdraft fees and $35.7 million in net income in 2020, while Woodforest reported $142.4 million in overdraft fees and $128.4 million in net income last year.

Aaron Klein, a fellow at the Brookings Institution and frequent critic of overdraft fees, called these types of banks "check cashers with a charter."

"These entities are not really banks in the traditional sense of taking deposits, making loans and helping customers and the economy," he wrote in a March op-ed. "They are a combination of payday lenders and check cashers, whose business model depends on a single product with a sky-high annual interest rate that is only paid by people who run out of money."

Banking Dive reached out to First National and Woodforest for comment but did not receive a response.

Changing customer expectations

In recent months, the nation’s largest banks and regional institutions have shifted toward offering new products and services that allow customers to avoid overdraft fees, through notifications, grace periods or even emergency lines of credit, yet it’s unclear if some of their smaller counterparts, which rely on overdraft fees as a source of income, can afford to make the same changes. 

And while many stakeholders would agree banks should rethink the overdraft fee model, it remains to be seen whether legislation or the market will ultimately dictate that change.

"The market may be creating a condition in the future where the customers’ expectation is some alternative to the traditional overdraft fee model," said Chris Williston, president and CEO of the Independent Bankers Association of Texas, the trade group that counts both Woodforest and First National as members. "If the market drives a different model, that's a lot less arbitrary to me than the government or think tanks trying to drive shutting down a consumer product."

Proponents for the model argue consumers voluntarily opt into overdraft protection to meet critical financial needs, such as buying gas, groceries or paying a mortgage.

"With nearly half of Americans unable to meet a $400 emergency expense, there are times when consumers need access to short-term liquidity — or an emergency safety net — which is why well-regulated banks offer overdraft options," said David Pommerehn, senior vice president and general counsel at the Consumer Bankers Association (CBA).

Customers are split over the fairness of overdraft fee charges, according to data from a survey published by Morning Consult in June.

About 52% of U.S. adults said they believed overdraft fees are an unfair penalty that disproportionately affects underprivileged consumers, while 48% said they believed the fees are a fair charge for a convenience offered by a bank when a consumer spends beyond their means, the survey found. 

Williston argued banks are already responding to customers who are looking for products that offer alternatives to overdraft fees — a shift driven, in part, by the growth of challenger banks that have long advertised their lack of overdraft fees and early access to direct deposit.

San Francisco-based Chime's SpotMe feature covers customers who overdraw as much as $200 past the amount in their account, while Varo Bank covers transactions up to $50 over a user's account balance. 

"Those customer expectations could very well change the overdraft game entirely," Williston said. "If those products become the customer expectation, you have to step in to do it. Otherwise, people will continue to flock to the challenger banks."

But not everyone agrees the market will resolve the issue by itself and generate more options for customers looking to avoid racking up multiple fees. 

"The numbers don't lie," Rep. Carolyn Maloney, D-NY, said, referencing the $8 billion in overdraft fees the nation’s largest banks collected last year. "Obviously, the other options aren't working."

Maloney this month introduced her Overdraft Protection Act, a piece of legislation the veteran lawmaker has put forward every Congress since 2009, but has yet to see pass. 

Maloney, whose bill would force more transparency on predatory overdraft practices, expressed confidence the measure would pass this session.

The bill would prevent banks from charging a customer more than one overdraft fee in any calendar month, and would limit to six the number of overdraft fees a bank can charge a customer per year.

The bill would further prevent banks from posting transactions in a way that would let it maximize overdraft fees, such as ordering transactions from the largest to the smallest, forcing customers to overdraw their balance more frequently.

It also requires banks to disclose their overdraft fee limit, opt-in policies and alternative options to overdraft coverage. 

But bank trade groups like the CBA said Maloney's bill would limit consumer choice.

"Consumers have the right to choose the products and services which best provide for their daily financial needs,” Pommerehn said. "Policymakers should be focused on encouraging innovation in the well-regulated and highly competitive banking sector rather than stifling the very choice and flexibility overdraft services offer."

Looking past potential losses

Some banks aren’t waiting for Congress to force change.

Frost Bank launched an overdraft grace feature in April that allows the San Antonio-based bank’s customers to overdraw their checking accounts on transactions up to $100.

Columbus, Ohio-based Huntington Bank last month launched Standby Cash, a digital-only loan product that would give eligible customers immediate access to a line of credit up to $1,000 with no interest or fees if they sign up for automatic payments. The bank began testing the product with community groups in various cities last summer. 

Without automatic payments, customers are charged a 1% monthly interest charge on the outstanding balance. Customers can qualify for Standby Cash based primarily on how they manage their checking account, and not their credit scores, the bank said.

Huntington will likely lose up to $1 million per month over Standby Cash, the bank's CEO, Steve Steinour, told Banking Dive last month. But he said he hopes the product will attract more customers and build loyalty among existing clients. 

Overdraft fees accounted for 2% of Huntington's revenue in 2020, according to investment bank Morgan Stanley. 

PNC has also revised its overdraft policy — a change the bank’s CEO, Bill Demchak, said would eliminate about $125 million to $150 million a year in revenue.

If an account is negative, PNC’s new "low cash mode" gives customers a 24-hour buffer to prevent or address overdrafts before fees are charged. 

Ally Bank took its revamp of the overdraft model a step further last month. After waiving overdraft fees between March and July 2020, the bank decided to eliminate the fees altogether. 

For Ally, the loss is relatively little. The bank collected $5 million in overdraft charges in 2020, or 0.07% of its total revenue, according to The Wall Street Journal.

Maloney said that although she is encouraged by some traditional banks’ efforts to implement products that help customers avoid overdraft fees, legislation is still needed. 

"It's hard for us to demand that a bank have a $1,000 line of credit. I think it's a wonderful thing that [Huntington] did it, but I think a better approach, going forward, is to stop the unfair, deceptive practices that push people into overdraft," Maloney said. 

'Less dependable'

Banks are rethinking overdraft fees not only because of pressure from fintechs and lawmakers, but also because of a drop in revenue from the fees. 

Industrywide, banks collected less in overdraft fees in 2020 — about $31.3 billion — than the $34.6 billion they took in a year earlier, financial data firm Moebs Services Inc. found.

For some consumers, the extended unemployment benefits and stimulus payments that were enacted amid the pandemic meant fewer customers were overdrawing their accounts, according to Corey Stone, a senior adviser at the Financial Health Network.

"What had been a dependable source of income became less dependable, and possibly more dispensable at some institutions who are already less reliant on it," Stone said. 

In addition to the positive publicity that comes with launching an overdraft avoidance product, banks may also be responding to developments that indicate they won't earn as much from overdraft in the future as they are today, he said. 

Competition from challenger banks is one reason, he said. Another could be what Stone calls the new "early wage access" industry. 

"These overdraft prevention services are either offered through the employer or it's offered by a third-party fintech who says, ‘We're going to tap into your employer's payroll data or tap into your bank account so that we can see when your payroll comes, use that information to give you a piece of the wages that you've earned in advance,’ to enable people to avoid overdraft," he said. 

Neobanks like Chime, Varo Bank and Current offer these services in addition to their no-overdraft fee accounts. Incumbents such as Fifth Third and Capital One have leaned into similar offerings.

"I don't know the extent to which [early wage access] is enabling people to avoid overdrafting in the long run, but I know that those services argue that they help their customers avoid overdraft," Stone said. "It would be great if banks could offer services that help people better manage their money. If you think about overdrafts being expensive credit — high fees for very small pieces of credit that you know the people who are overdrafting regularly are missing — they're just overshooting their spending by a little bit. And that's all it takes. Then helping them not overshoot wouldn't be that hard."

But the incentive for banks, of course, is still to make money, he said.

In a white paper titled "Beyond Overdraft" published by Oliver Wyman last year, Stone and fellow authors Dennis Chira and Aaron Fine, propose banks design a solution that consumers are willing to pay $10 a month for.

"[I]f you can get one new frequent overdrafter to join the bank and one existing occasional overdrafter to take-up the solution for each existing frequent overdrafter you convert, then the math falls into place," the authors wrote. "[W]ith a $10 monthly fee, a typical bank can convert all of its frequent overdrafters to a no-overdraft-fee proposition and still break even if it just acquires one new frequent overdrafter and converts one existing occasional overdrafter with the new proposition."

Some banks are shifting their aim to the financial health of their customers, said Melissa Gopnik, senior vice president of Commonwealth, a nonprofit focused on financial security for vulnerable populations.

"Overdraft fees produced a whole lot of revenue for financial institutions, but not necessarily in the way that advances the financial health of their customers," she said. "And so I think what this shows is a real kind of change in the financial industry, away from thinking of themselves in terms of doing transactions, making sure your deposit happened, your withdrawal happened and dotting the T's and the I's. It’s much more about thinking about their customers' financial health."

A third-party solution?

Joel Schwartz, a former banker at St. Louis-based First Bank, saw firsthand and frequently the frustration among consumers regarding overdraft fees. 

"My customers were coming in every day agitated, upset and frustrated saying, 'Why didn't you help me with my account?' We had a CEO who would say we needed the fees and, of course, the regulator was saying this is completely out of control," he said. "I knew there had to be a better way for everybody to have a win-win situation."

The experience led him to launch DoubleCheck Solutions, a fintech that partners with banks that are looking to move away from charging overdraft fees.   

DoubleCheck notifies customers in real time if they have insufficient funds in their account, allowing them to alter the bank's decisions on what gets paid, using a range of payment methods. 

"It’s about control, above everything," Schwartz said. 

Customers of banks and credit unions that partner with DoubleCheck are automatically given access to DoubleCheck’s services when they overdraft their accounts.

DoubleCheck notifies the customer via text, email or optional robocall when their account has been overdrawn, and provides the customer with several options. 

Once authenticated, the customer is presented with an entire pay scenario — which items are being paid, which ones have been returned and which ones have been covered in their overdraft.

The customer can choose to alter a bank’s pay decision, pay off the deficit with a credit card or a third party, or do nothing, Schwartz said. 

The technology, Schwartz said, allows the customer to make decisions about their account in real time, rather than rely on a decision to opt in or out of an overdraft protection service that was made when the account was opened. 

DoubleCheck charges the financial institution an integration fee to get its platform up and running, but makes most of its revenue from the transaction fee it charges the customer for using the product. DoubleCheck splits the revenue from the fee with the financial institution, which sets the pricing, Schwartz said.

The company said it has six customers under contract, all in various stages of integration.

Schwartz said banks need to alter their approach to overdraft, but he doesn’t think the service should be eliminated. 

"Eliminating overdraft altogether can exacerbate the problem," he said. "What if we had no overdraft? We’d just send everything back. But what if that was my mortgage or my kid’s tuition?"

Schwartz said DoubleCheck’s services are also available for small businesses.

"A lot of them, especially coming out of the pandemic, need something to be able to manage the cash flow, and they're going to need other tools in order to be able to keep their doors open," he said.