Federal Reserve Acts to Regulate Overdraft Fees

May 14, 2010

Author: Kirsten E. Keefe

NSF fees, known as nonsufficient fund fees, or overdraft fees, are essentially loans made to bank account holders when the consumer overdraws on their account (as a result of a check, electronic payment, ATM withdrawal or point of sale purchase) rather than the bank denying the transaction.  These fees have ballooned into a giant profit-generating industry in the past six years for financial institutions.  The amount of the fee is set by each bank, with no prescribed limits in law, and is the same amount, regardless of the amount of the overdraft.  Some banks charge recurrent fees, until the account is brought current.

Background:  Overdraft fees as Big Business

Prior to 2006, bank fees were limited to $10 in New York for a bounced check.  A federal regulation in 2004, however, exempted national banks from New York’s limit which lead to a rollback of our state regulation and gave parity to all financial institutions to determine the fees they would charge for overdraft items.1  Thus came a new source of profiteering by the industry and since then, the landscape has changed dramatically: in 2004, 80% of banks still declined overdraft usage on debit card transactions and charged no fees, but by 2009, 81% of banks surveyed by the FDIC allowed overdrafts on debit transactions and charged fees.2 Touted as a ‘service’ to bank account holders for covering checks that would otherwise bounce, or debit purchases that exceed the account balance, overdraft fee income for financial institutions rose 35% between 2006 and 2008.3 Account holders have been automatically enrolled in these programs, usually without noticing it – until they trip up and incur a fee.

The median overdraft fee charged by financial institutions is about $35 and some banks charge their fee every few days until the account becomes current.4  These fees far exceed transaction costs or the credit risk to the bank.  The Center for Responsible Lending (CRL) reports that almost half of the fees (46%) are incurred as the result of a debit card or ATM overdraft – the average transaction being just $20.  Thus, while institutions extended $21.3 billion in credit to cover overdrafts, consumers paid $23.7 billion in fees.5   In addition to the excessive amount of the fees, banks generate fees by re-ordering transactions, paying the highest items first and causing overdrafts on subsequent smaller transactions that actually occurred earlier in time and would have been covered if the transactions were paid in real time.6

Overdraft fees disproportionately affect lower-income, single, non-white individual and renters, according to CRL:  71% of all overdraft fees are paid by just 16% of the people who overdraft.7  When polled, 88% of consumers want to choose whether they have this option and 80% would rather have a transaction denied at the point of sale, rather than incur the fee.8 No one denies that it is the responsibility of the  account holder to ensure that they do not spend more than what is contained in their account.  Banks also should be entitled to recoup transaction costs and impose reasonable fees to deter behavior.  However, the fast paced world of financial practices and pressure for consumers to move from using cash to debit or credit cards (think of the VISA television ads intended to make consumers like my father who still pay with cash feel guilty for holding up the checkout line!), coupled with tricks and traps imbedded in the system to induce overdraft fees have created a reality that over 50 million Americans overdrew their checking account over a 12-month period.9

New Rule:  Opt-in

In an effort to afford greater protections to consumers, the Federal Reserve Board adopted rules in November 2009 which prohibit financial institutions from charging overdraft fees without the account holder’s consent.10  The rule applies to all consumers, including existing account holders, and specifically requires the consumer to opt-in to their bank’s overdraft program for fees on ATM and debit transactions, versus being automatically enrolled and having to opt-out.  Consumers have an ongoing right to revoke consent.  No affirmative consent, however, is required for overdraft fees to be imposed on check or electronic payments.  The rule goes into effect July 1, 2010.  The Federal Reserve is in the process of writing clarifying regulations.11

Advocates are concerned that unless sufficient oversight is provided, the notices that banks send to their account holders letting them know about the opt-in feature will mislead, or scare consumers into signing up for their programs.12  An alternative is for banks to deny debit card purchases to go through if there is insufficient money in the account.  Citibank has never authorized an overdraft at the ATM or debit point of sale where the customer did not have sufficient funds at the time.  Bank of America announced in March that they are following Citibank’s lead.

Pending Federal Legislation

While the new “opt-in” rule is seen as a step in the right direction by the consumer advocacy community, this change alone falls far short of providing the protections necessary to prevent abuses.  Congresswoman Carolyn Maloney, representing Manhattan and Queens in New York, has proposed the Overdraft Protection Act (HR 3904) which would provide a full range of protections for consumers when it comes to overdraft fees.  The bill would extend “opt-in” to cover checks, and would require financial institutions to provide cost of credit disclosures under the Truth in Lending Act (TILA), to enable consumers to compare the cost of this type of credit with other forms of credit. 

Additional protections in the legislation include:  capping the amount of the fee to what is reasonable and proportional to the bank’s cost; limit the number of fees a bank or credit union can charge to 1 per month, and 6 per year;  essentially prohibit multiple overdraft fees for a single debit offense; require ATMs to warn consumers in real-time doing cash withdrawals that a fee will be imposed;  prohibit institutions from manipulating transaction posting order and require posting in real time; and  prohibit overdraft fees caused solely by debit holds that exceed the actual transaction amount.13

Footnotes

 1  See generally 12, Code of Federal Regulations, Section 7.4002 (allows national banks to impose charges and fees on their customers regardless of any state law); 12, Code of Federal Regulations, Section 557.12(f) (allows federal savings associations to impose charges and fees regardless of any state laws); Joint Guidance on Overdraft Protection Programs, 70 Federal Register 9127 (February 24, 2005) (applicable to banks and trust companies) and Joint Guidance on Overdraft Protection Programs, 70 Federal Register 8428 (February 18, 2005) (applicable to savings banks and savings and loan associations); See also NY Banking Law 14-g and 14-h, and Part 6.8 and Part 32 of the General Regulations of the Banking Board (allows financial institutions to set own fees for insufficient funds and gives parity to state-chartered bank and trust companies, and savings banks and savings and loan associations).
 2  Quick Facts on Overdraft Loans, Center for Responsible Lending (April 9, 2009), available at http://www.responsiblelending.org/overdraft-loans/research-analysis/quick-facts-on-overdraft-loans.html.
 3  Id.  See also FDIC Study of Bank Overdraft Programs, Federal Deposit Insurance Corporation (November 2008), available at http://www.fdic.gov/bank/analytical/overdraft/.
 4  Q and A on Overdraft Loans and H.R. 3904, and the Overdraft Protection Act of 2009, Consumer Federation of America,  available at:  http://www.consumerfed.org/.
 5  Quick Facts on Overdraft Loans, CRL.
 6  The Center for Responsible Lending collects stories from consumers on and ongoing basis.  To read these stories, or add one of your own online, go to “Overdraft Abuse:  Readers’ Stories (Submit Yours)” at   http://www.responsiblelending.org/overdraft-loans/tools-resources/overdraft-abuse.html.
 7  Quick Facts on Overdraft Loans, CRL.
 8  Overdraft Fees and Opting In:  A survey of consumer preferences, Center for Responsible Lending (March 2009), available at http://www.responsiblelending.org/overdraft-loans/research-analysis/consumer-preference-opt-in.pdf.
 9  Quick Facts on Overdraft Loans, CRL.
 10  74 FR 59033 (Regulation E final rule); See also Highlights of Final Rules Regarding Overdraft Services, Board of Governors of the Federal Reserve, available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20091112a2.pdf.
 11  Proposed regulations were published March 1, 2010 with final comments from the public due March 31, 2010.  The proposal can be found at the FEDERAL RESERVE SYSTEM, 12 CFR Part 205 [Regulation E; Docket No. R-1343], available at <http://edocket.access.gpo.gov/2010/2010-3720.htm>.
 12  The Federal Reserve developed a model form entitled, “What You Need to Know about Overdrafts and Overdraft Fees,” available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20091112a3.pdf.  Use of this form by institutions is not mandatory.
 13  For more information on pending legislation, go tohttp://maloney.house.gov/.