How to reform overdraft fees

By Felix Salmon
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?

15 comments

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My checks each have my account number printed on them. So it can’t be that sensitive or I could never use a check.

Posted by dmo | Report as abusive

Again, this is simple. All people need to do is stop writing hot checks and using debit cards when there’s no money in their accounts. Keeping track of accounts is not rocket science and there’s no reason to be overdrawn, except due to account holder negligence. If that’s done, there’s no overdraft fees, no bounced check fees, etc. It wouldn’t matter if the overdraft fees were $10,000 per item. Everything has it’s price, and bouncing checks does nothing but enable the banks to make money.

Posted by Frank | Report as abusive

With regards to your last point – bank account numbers in the US are semi-sensitive and need to be so, given the way the ACH system is setup.

In the US, an electronic debit on an individual P’s account by a merchant/payee M requires only that M receive an explicit authorization from P and keep it on file.

Whereas in Europe (I know this for a fact in UK, but I think it applies to the Eurozone as well), P’s bank B needs to receive a mandate for the transaction (or a series of transactions) from P.

This makes it easier for a scammer with access to an ACH capable merchant account and P’s bank account number to issue debits on P’s account without an explicit approval from P. There are hundreds of thousands of these merchants and not all of them are scrupulous and many do not have adequate controls against their ACH merchant accounts being misused.

There are some protections, however. P can challenge the transaction up to 60 days for unauthorized debits (and up to 1 year for fraud). But the onus is on the customer to challenge the unauthorized transactions and in the meantime they are out the money and could be bouncing checks and debit card transactions without knowing their account has been drained.

So, it is generally a good idea not to give out your bank account numbers very widely (also a good reason not to write checks to complete strangers).

Posted by Rajesh | Report as abusive

where does it say that debit cards have no overdraft fees? at least in the uk they do. (one example was 15 pound a day, no matter how big the overdraft, could be just one pence)
I think this is due to the fact that in most other european countries the balance is checked, and if you’d have to overdraw, payment is declined. In the uk however it seems that the balance is also checked, but you are allowed to overdraw this once, (like I said, could be just one pence) so there if you don’t carefully check your balance or keep enough money to pay back in, the bank gets lots of extra cash from your next pay check, for as low as a one pence “loan”.

Posted by step21 | Report as abusive

Just to confirm step21′s point, there definitely are NSF fees on debit card transactions.

In the early 2000′s most financial institutions rewrote the section of their account agreements that discussed NSF “checks” to use the broader language about items, including electronic transactons, specifically so that they would have a contractual basis for charging such fees.

It’s also important to remember that the technology used to determine funds availability for debit transactions is almost identical to that used for approving credit transactions – in both cases, the VISA/MC interchange systems allow banks to set up “cushions” to allow some overdrawn transactions to occur even though funds, or creditline, are not really available. Some of these cushions are quite elaborately constructed to take the customer’s history and creditworthiness into consideration.

There is a debate out there within the banking and regulatory community about whether it is more appropriate to simply cut customers off when they’re out of funds, or whether the better approach is to allow them to overspend a bit.

Since people really don’t like having their transactions declined at the point of sale, and banks lose customers that are angered by having their purchases denied, the default position is to allow them to overspend – but banks do take risks and do incur some significant costs in allowing this, so this is not a black-and-white issue.

Posted by Eric Dewey | Report as abusive

Yes, please.

And how about a fee for using checks in general? Anything to get that person in front of me in line at the grocery store to hurry the hell and swipe her card.

Posted by mattmc | Report as abusive

Even if you DO opt out of this “overdraft protection” it’s not guaranteed. It doesn’t work for overseas withdrawals, for example. When I was in Eastern Europe recently, I pulled some cash out of my Wachovia checking account. I keep that account for traveling to strange countries, I only keep about $300-$400 there. Well, somehow I went over (did not account for Visa conversion fees) and the Wachovia still screwed me for $55 of overdraft fees — this is DESPITE ME HAVING OPTED OUT of overdraft protection. So, there.

Posted by Susan | Report as abusive

Oh – and one other thing they did to push me below the zero balance was to a) charge me $5 for balance inquiries (this is Wachovia) and b) bunch them all in a group of 4 and hit me right away with a $20 “INTL ATM INQ SERVICE FEE”, thereby pushing me below zero. Scumbags.

Posted by Susan | Report as abusive

If a merchant clearly posts a bounced check fee like I see the grocery store and Walmart do, I see no reason that those fees should be capped.

“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.”
Who would pay for this? That seems like a subsidy for people with checking accounts paid for by people with checking accounts. If checking accounts are fabulous enough that we think everyone should have them (even if many cannot afford them) then we should collectively finance the subsidies required to make that happen, not make the banks subsidize it.

Felix, I wonder if you could synthesize for us why you feel NSF fees are an undesirable practice into some sort of generalization we could apply to any banking fee. Something like a Salmon Bank Fee Smell Test.

Looking back to your July 2 entries on the subject, you seem to be objecting to NSF fees on the basis that they disproportionately affect the poor, innumerate, and elderly (or some combination thereof)–a class you describe as being “precisely the people least able to afford [such fees].” You call it a “tax on poverty” (though I hate the usage of tax in this context; rents feels better to me). But you also seem to appeal to notions of usury: “The implicit interest rate on these ‘loans’… is in the thousands of percent.”

The usury route seems the more convincing, at least to me. And it also seems better suited to spinning-off into a general principle. But I’m curious: Why the scare quotes around the word loan? I mean, I get why the banks would want to avoid calling overdraft protection a loan–what with there being usury laws and all–but do you give this line of thinking any credence?

“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.”

The second part of your statement may not be accurate, my understanding is most banks will allow debit card transactions to go through despite insufficient funds. This of course, generates a fee for the bank. If my understanding is correct (and I am fairly confident it is), we would need to address overdrafts on debit charges.

Source: http://www.usatoday.com/money/perfi/cred it/2007-01-24-debit-card-fees_x.htm

Posted by Brad Ford | Report as abusive

Stupid question: Is there such a thing as a combination checking-and-credit account? That is, a checking account on which you can overdraw up to a stated credit limit, on which balances you owe a certain stated APR? This seems close to what you’ve described. I’m trying to figure out why this doesn’t already exist. Seems like a more useful account than having two separate accounts.

Thanks, Felix – that looks very thoughtful.

Requiring banks to offer free no-frills checking is still a little problematic.

Assuming that low income customers cost the bank more than they pay (after we cap fees and outlaw minimum balance requirements), then (1) requiring banks to provide these accounts constitutes a subsidy from the other customers to the low income customers and (2) that subsidy will be larger for banks that have disproportionate amounts of low income customers.

This is probably manageable and maybe a fair price for don’t think the subsidy will be a huge drag, and you keeping the government out of the banking business — I although you will get even more into the business of scrutizing banks for “redlining” low-income customers.

On a related subject, I wish there were something more we could do to get basic no-frills checking accounts to low-income people. It breaks my heart when I see people paying all the fees that pile up when you don’t have a checking account.

Posted by J Mann | Report as abusive

Your reader need to read a book called “your bank is screwing you over.”its a great book, published in 1997 and outlines every way banks manipulate the system and are a monopoly of greed and massive profit. It warns of the entire collapse before the glassel.. Act passed. Written by a former bank CEO u found it at the library.

Posted by zoey | Report as abusive

Banks have used technology to make it very easy for consumers to track their accounts and make smart decisions about their own spending. They have online statements 24 hours a day with mobile options on your phone for many. You can also call anytime and go to the ATM to get your current balance. They also offer a line of credit to just about anyone that would help you avoid all of this but no one ever signs up for it leaving you vulnerable to overdraft fees.

The problem is we have people with $150 to their name and they expect the bank to take all the risk of covering their short term financial needs without any risk to them. Do you expect the grocery store or dry cleaners to just let you do business with them if you can’t afford it or you forgot to make a deposit…NO..they would all go out of business and banks are no different

These people are lucky their not eating lunch with their family and then getting the charge on their debit denied instead of the bank paying for it and saving them the embarrassment. I don’t think they let people wash dishes anymore.

Here’s my solution. If you can’t keep your balance above $200 you have no need for a bank account. No bank account means NO FEES!! Do yourself a favor and don’t spend what you don’t have!!

Posted by DB | Report as abusive