How to reform overdraft fees

July 7, 2009

A couple of very interesting comments have appeared on my blog entry on regulating bank fees in general, and overdraft fees in particular. J Mann asks what exactly I’m proposing, and what I think the consequences might be:

Are you thinking about (1) requiring banks to allow customers to opt-out of overdraft protection (or maybe requiring opt-in);

(2) setting maximum overdraft fees, but permitting banks to decline to provide ovedraft financing altogether; or

(3) requiring banks to provide overdraft financing to all checking customers and setting maximum rates for that financing?

It seems to me that the likely consequences would be some combination of

(a) banks declining to offer overdraft financing, which would leave people paying bounced check fees to their payees;

(b) banks reinstuting minimum balances for checking accounts; and/or

(c) banks removing interest and other benefits from checking accounts.

Those consequences might be worth it, but I’m curious which reform you think would get us the maximum benefit/cost ratio.

My proposal would be that banks be given a choice: they can offer automatic overdraft protection, but only if it’s free. (They can charge an annualized interest rate on the overdraft, but no set fees.) If they want to charge fees as well as an interest rate for overdraft protection, then that protection would have to be opt-in rather than opt-out, and the fees should be prominently disclosed at the opt-in stage. And yes, fees would be capped: I would say a $20 cap was reasonable, with a limit of one such fee per day.

What would the consequences be? Yes, for sure there would be more bounced-check fees. (Which should also be capped.) But checks can and should be increasingly rare things. We’re moving into a world where debit cards are replacing checks, and transactions simply don’t go through if funds aren’t available: there’s no such thing as a bounced-debit-transaction fee. Similarly ATM withdrawals would simply be declined, rather than triggering overdraft fees.

Would banks reinstitute minimum balances or otherwise stop banking the kind of poorer customers who currently generate lots of fees but who otherwise aren’t very profitable for the banks? That’s a danger, yes. We don’t want these regulations to result in a large increase in the unbanked. Maybe banks should be required by law to offer simple no-frills checking accounts for customers who can’t meet minimum-balance requirements and don’t want to pay monthly checking-account fees.

As for interest-bearing checking accounts, those beasts are rare enough to begin with that I doubt many people would notice their passing altogether. So yes, there will be costs, but I’m pretty sure the benefits would be much greater.

J Mann’s comment was followed up by one from Argel, who got very excited about the fact that a previous commenter had revealed his account number at Citibank. Is this a particularly dangerous thing to do? In Europe, people give out their account number all the time — if I want to pay you some money, I just wire the money into your account, which is free, but does require my having your account number. In the US, by contrast, people are very protective indeed of their bank account numbers. Is that for good reason? Or is it something which will just change slowly if and when we move from checks to electronic transfers?


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