Overdraft fee datapoints of the day

By Felix Salmon
October 6, 2009
has a new report on overdraft fees, which has some startling numbers on the degree to which these things have increased in recent years:

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The Center for Responsible Lending has a new report on overdraft fees, which has some startling numbers on the degree to which these things have increased in recent years:

Overdraft fee income for banks and credit unions rose 35 percent between 2006 and 2008, going from $17.5 billion to $23.7 billion. Add in non-sufficient fund fees, and the totals rise to $25.3 billion and $34.3 billion, respectively. (The difference between an overdraft fee and an NSF fee is that an overdraft fee is charged when the payment is made; an NSF fee, or bounced-check fee, is charged when the payment is not made.)

The Center also notes that “as recently as 2004, 80 percent of all institutions denied debit card overdrafts” — it’s astonishing how quickly such charges went from the exception to the rule.

Overdraft fees now dwarf the actual overdrafts themselves:

For 2008, we estimate that checking account holders receive only $21.3 billion in credit for the $23.7 billion they pay in overdraft loan fees. Put another way, consumers were obligated to repay $45 billion for $21.3 billion in extremely short-term credit.

The Center has some good recommendations, including this one:

Require that overdraft fees be reasonable and proportional to the actual cost to the financial institution of covering the overdraft. On average, overdraft fees exceed the amount of credit extended, which is particularly troubling given the short time period until repayment—usually only a few days. Since banks are able to repay themselves out of the accountholder’s next deposit, these loans carry a low default risk relative to their high cost. Overdraft fees should be proportional to the actual cost to the institution of covering the overdraft, taking into account the cost of funds, default risk, and a reasonable profit margin. Indeed, a product designed to be proportional to the cost to the institution of covering the overdraft already exists—an overdraft line of credit at a reasonable interest rate.

In fact, the status quo is even worse than the Center here implies. Yes, it’s true that banks are able to repay themselves out of the accountholder’s next deposit. But they never do.

Where I come from (England), an overdraft is simply a negative balance on your checking account. You pay interest so long as the balance is negative, and if you put in enough money to bring the balance back into the black, you stop paying interest. Not here. In the US, there’s normally no such thing as a negative balance on your checking account: instead, when you go into overdraft, you not only pay the usurious overdraft fees, but you also start running up a debit balance on your overdraft account. If you then deposit money into your checking account, it’s entirely possible (and indeed common) to have a positive balance in your checking account and an overdraft, all at the same time. In order to get rid of the overdraft, you need to actively transfer money from your checking account to pay off your overdraft — which of course you’re never going to do unless and until you find out that you’re overdrawn in the first place. Which might not happen until you get your next month’s bank statement.

If I may, then, I’d like to make one addition to the Center’s recommendations: that all deposits into checking accounts be put first towards any overdraft, and only then towards a new positive balance. But that of course would be consumer-friendly, so it’s probably never going to happen.

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