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 . . .

— JSM