Thursday, August 21, 2008

Citizens Bank: Maybe not your typical bank, but typical overdraft fees apply

Following up on my earlier post on Consumer Overdraft Protection (and always curious about how commercial matters are working in practice), I made a call to one of the banks I use, Citizens Bank, to ask. I was surprised to find out that they charge a whopping $39 per item on overdrafts, whether by debit or by paper check (of course, not tied in any respect to the size of the transaction). This is higher than the average of average $34.65 per item reported in the Consumer Federation of America study. It makes sense since overdraft fees are a big money maker for banks. If consumers write fewer paper checks, then banks was to recoup the income with debit card overdraft fees.

According to a USA Today article earlier this year, banks used to just deny debit card purchases (in the same way many credit cards do) in the event a consumer had too little money in their account. So, the banks charged overdraft fees primarily on bounced checks. In the USA Today article, a representative of Wachovia explained that debit card overdrafts are for customer “convenience” and that banks don’t really know if a particular transaction will overdraw the account. Underscoring the small size of many transactions, Greg McBride of commented “"I don't know a consumer on the street who's willing to pay a $35 overdraft fee to have a $3 Slurpee." McBride has a point here. Moreover, many colleges now have partnered with banks to allow student id cards to operate as debit cards. This includes the overdraft fees on debit charges.

I asked the Citizens Bank representative about opting-out of overdraft protection. The rep acted like they had never heard of such a thing. Why would you want that I was asked? Then I explained to her the practices of PNC and some other banks beginning to offer opting out to customers (and I mentioned the proposals before the Federal Reserve). So, I asked again if I could opt out and what programs the bank had. She then told me that in fact, I could either entirely opt-out or just opt-out for the debit card simply by asking over the phone (no forms to fill out). She did advise me that they don’t always know if a debit card transaction will in fact overdraw an account. I chose to opt-out for the debit card just in case.

The Federal Reserve’s proposed regulations on overdraft protection appear more needed than ever. This is true, even if they only address the notice to consumers and some basic opting-out options. I understand that some customers may want full overdraft protection (even against the smaller debit card purchases). It is concerning, though, that even a consumer who knows they want to opt-out may have difficulty in getting the bank to accept the opting-out. Those who don’t know about how to opt-out or who cannot master the bank bureaucracy are out of luck.


Sunday, August 17, 2008

Consumer Overdraft Protection

My first class in Negotiable Instruments tomorrow covers the issue of checking overdrafts, including the problem of excessive fees. Of course, under UCC 4-401 a check is properly payable even if it creates an overdraft. Hence, the overdraft protection (for a fee of course) both loved and hated by consumers. The students will surely ask about these fees, which according to the Consumer Federation of America average $34.65 and total about $1.7 billion in fees paid by consumers. The Center for Responsible Lending (CRL) complains that overdraft fees maximize the profit for the banks by: “automatically putting customers into overdraft systems by default, routinely reordering daily transactions to subtract highest-dollar amounts first, and holding deposits longer than necessary.”

One of the big complaints about the overdraft fees is that banks use a system whereby most consumers automatically have some overdraft protection whether they want it or not. In response, the Federal Reserve Federal Board proposed rules in May 2008 that allow customers to opt-out of bank overdraft loans to avoid future fees and impose other disclosure requirements regarding fees. At least PNC Bank has adopted the opt-out procedure. The CRL complains that the proposed rules don’t go far enough because they put the burden on the consumer to opt-out of the bank overdraft programs. Rather, overdraft protection should be opt-in in nature. Banks, like Wachovia, have objected to the rulemaking by commenting that the proposed required disclosures are too onerous and should only apply to banks that market their overdraft services in any event.

I tend to agree with CRL’s comments that the proposed rules don’t really go far enough. Since many overdrafts these days occur on small debit card transactions, consumers might genuinely prefer to be denied on the spot for these transactions, rather than get the $34 overdraft charge. It might be advantageous for consumers to have a choice that would allow them to have overdraft protection on paper checks, yet not on debit card transactions. A broad-based opt-out doesn’t address the overdraft charges on these smaller debit transactions. An issue that is likely to increase as consumers use their debit cards more and more. The CRL’s complaints about the disproportionate impact the overdraft programs have on the poor and senior citizens on social security is also concerning.

It seems that one of the underlying issues here is the way that the banks charge overdraft fees and the types of protections they offer consumers. Without an opt-in system, it is hard to imagine that the more aggressive banks will change their programs as there is no market incentive to do so. Further, the big gorilla lurking in the corner here is also the size of the fee charged per transaction in the first place. Until the Federal Reserve reconsiders its interpretation that these overdraft fees are not regulated as loans per se, banks will seem to have broad discretion in the amount charged. We'll see what the students say about this in class tomorrow . . .


Wednesday, August 13, 2008

Credit Card Fair Fee Act

Update: The final amended language of the Credit Card Fair Fee Act, as reported by the House Judiciary Committee, is now available. It employs a rather clever two-step device in an attempt to stimulate negotiated merchant fees. First, as blogged below, the bill extends antitrust immunity to groups of merchants and banks negotiating card acceptance fees. But then, it pulls the immunity back whenever a card issuer, or acquirer, or a merchant “is engaged in any unlawful boycott.”

Could this language mean that neither the merchant group, nor the banks, can walk away from the negotiations if the other side does not agree to acceptable terms? The take-it-or-leave-it approach has long been the banks’ modus operandi. Taking this threat from their arsenal could meaningfully change the market dynamic. Still, one has to wonder how a negotiation is supposed to proceed if the parties can’t threaten to walk away.

The bill would require the largest merchants, card issuers, and acquirers to produce cost information to the DOJ Antitrust Division, and Division representatives would take part in the negotiations. All this seems to stack the deck in favor of some sort of cost-based, negotiated merchant fee, which would be fine if costs served as a basis for setting an efficient fee. Unfortunately, they don’t; as the economist Michael Katz has explained.

A competitive means to set merchant fees would likely be superior to a cost-based system. There are at least three proposals in the literature to set fees competitively: (1) placing the costs of payment mechanisms on consumers by, for example, allowing merchants to surcharge card transactions; (2) empowering merchants to select the network over which a payment will be processed; and (3) forcing large card issuers to negotiate their own interchange fees. I have advocated for the latter, but all three seem to hold more promise that the Judiciary Committee’s current approach.

Original Blog: On July 16, the House Judiciary Committee reported out Congressman Conyers’ Credit Card Fair Fee Act over a sharply divided, yet surprisingly non-partisan, 19-16 vote. The amended text is not yet available, but you can piece it together from the hearing transcript at

The bill as reported differed significantly from the bill originally introduced in March. Both bills are intended to combat the problem that merchants need to accept Visa and MasterCard so desperately that they have little ability to resist fee increases. At the heart of both the original March bill and the amended bill is essentially a bargaining order, requiring the banks issuing cards on large systems to negotiate with merchant groups on interchange fees and exempting from antitrust scrutiny the agreements reached in these negotiations. A key provision of the original bill would have created a panel of interchange fee judges, who would have set the fees if the parties could not agree. The Department of Justice and Federal Trade Commission both opposed the bill and were particularly critical of the panel of judges. At the July 16 hearing, Congressman Conyers removed the panel proposal from the bill. In addition, he added provisions (1) permitting small banks and credit unions to exempt themselves from these negotiations and (2) requiring that merchants do not simply retain fee reductions as profit.

This bill fails to engage the real problem with interchange fees, because a bargaining order is unlikely to reduce the card systems’ market power. Removing the judicial panel means that there is no real threat if the card companies fail to engage in meaningful bargaining. Still, eliminating the panel was a wise decision. Efficient interchange fee setting cannot track costs or any other factor accessible to a panel of experts. Appropriate fee setting must take account of demand conditions that are simply inaccessible to a regulator and probably the market participants as well. Given that, there seems to be little reason to provide an antitrust exemption. Who knows what mischief these bargaining groups might get themselves into?

The remedy to the interchange problem will ultimately be competitive, not regulatory. Congress could bring this about by simply requiring the large card-issuing banks to set their own interchange fees. If Discover can set an independent merchant fee with a market share of 5-6% of transaction volume, Citibank, Chase, Bank of America, CapitalOne, and perhaps a handful of others should be able to do so as well. Merchants would have substantially more leverage if they could refuse one issuer’s cards as opposed to the entire Visa or MasterCard association. Congress could achieve this result by simply prohibiting the card systems from enforcing the aspect of their honor-all-cards rule that requires merchants to accept the cards of every issuer on the network. Traditionally, this sort of remedy has been opposed as unworkable. After all, there are thousands of issuing banks. Requiring all of them to set their own fees, many have claimed, would be a mess. One positive aspect of Fair Fee bill is that it apparently recognizes that the rules that apply to the big issuers should not necessarily apply to smaller players. The bill applies only to systems with more than 20% of card volume and permits small banks and credit unions to exempt themselves from the negotiations. A competitive bill might require only those issuers with more than 5% of card volume to set their own fees. Without the large issuers in the mix, Visa and MasterCard could continue to set interchange fees for their thousands of smaller issuers without the power to compel merchant acceptance that has led to excessively high fees.