The perfect overdraft

By Felix Salmon
March 10, 2010
BofA's decision to abolish overdraft fees on debit-card purchases? Josh Duboff says it's "kind of undeniably great", James Kwak says it's a good thing, and the Center for Responsible Lending says that it's a GOOD thing. Only Kevin Drum spies a fly in the ointment:

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What to make of BofA’s decision to abolish overdraft fees on debit-card purchases? Josh Duboff says it’s “kind of undeniably great”, James Kwak says it’s a good thing, and the Center for Responsible Lending says that it’s a GOOD thing. Only Kevin Drum spies a fly in the ointment:

It just doesn’t make sense to eliminate overdraft protection entirely. Other alternatives are simpler, better for consumers, and more profitable for Bank of America. Something just doesn’t smell right here.

Kevin’s hit on something important here: while this is undoubtedly an improvement on the status quo ante, it’s far from optimal.

What I’d love to see, maybe from BankSimple, when it finally launches, is a UK-style overdraft. This has two main features which one almost never sees in the US:

  1. It has no fees attached; you just pay interest, per day, on the amount that you’re overdrawn.
  2. It’s a negative balance on your checking account, rather than a separate loan facility: as a result, if you’re overdrawn and you deposit more than that amount into your account, the overdraft automatically disappears.

If this works in the UK (which also, incidentally, has much more consumer-friendly ATM fees than the US has), I can’t see why it couldn’t work in the US. But BofA chose a very different route. Why? I suspect because they want to keep the fee income from ATM withdrawals and checks, when insufficient funds are available. If you get rid of overdraft fees on debit card purchases, it’s much easier to keep them on everything else.

Comments
6 comments so far

Here’s a simple fix: If you have a Bank A checking account and a Bank A credit card, you link one to the other. Seems clean.

What’s more, I could:

(a) consolidate two cards into one, and
(b) free up the balance I keep in my checking account that I use as a buffer against accidental overdraft and put it to more productive purposes, e.g. plowing it into a CD.

What am I missing?

Posted by Sandrew | Report as abusive

The barriers, Felix, to the UK setup that you cite – which is admittedly a nice setup that should be looked at – have two principal drivers, with one curious fact that makes the status quo not really matter to most:

1) Overdraft income exceeds net income ( you have mentioned this ), an average of 42% in the industry is from the EFT channel ( BoA debit cards, for instance )

2) Regulatory structures have put up significant roadblocks for institutions to structure their programs in that way.

3) On average in the industry, 85% of customers have NEVER had an overdraft transaction.

For many banks, #1 stops reform in its tracks – they need the income to keep rates even somewhere near competitive with banks with the TBTF financial advantage. If the bank can get past #1, then there is still the fact that the regulatory hurdles and compliance issues in managing accounts that way make it a tangly mess – I don’t know anyone at the bank I work at that is gung-ho about making complex changes that have a negative financial return, and further, makes absolutely no difference to the overwhelming majority of its customers.

Banks are typically not market makers – even small community banks with a very deep reach into a particular community – there is always someone ready to take on the business and do it in a way that the consumer expects. Until there is a tectonic shift in the industry that increases lending rates, convinces consumers that all of these complex transactional services are not actually free to operate, and a large number of consumers demand products for OD protection that aren’t inherently “gougey”, nothing is going to happen.

I work at a mutual institution in a small community. I think that the structure is unsustainable and inherently biased to finance the expensive transactional services everyone expects for free on the backs of the people most unable to afford it. Its backwards. But everyone wants free access to their money at any ATM and online banking that makes their money digitally liquid. Those are not cheap services to provide. Nor are any of the other services we expect to receive free when we have a checking account or even a savings account with a nickel in it. When are we going to pony up and pay for these services like we pay for stock transactions or groceries or internet service? Right now the people on the financial fringe are paying for those services on behalf of the rest of us.

How do you think we can change that? Seriously. I am paying attention closely.

Posted by Ken_H | Report as abusive

ing direct has this overdraft technique. it’s fantastic. the rate is only 7.99 percent or something.

Posted by rmbjspd | Report as abusive

Oops. BofA already thought of it, but there’s a catch, called the Overdraft Protection Transfer Fee:

“Link your checking account to a second Bank of America account – savings or credit card. Then, if you are about to overdraw your checking account, we’ll automatically transfer available funds from the linked account to help cover the overdraft.

“There is no cost to enroll in Overdraft Protection. If you use Overdraft Protection, you will pay an Overdraft Protection Transfer fee but typically, this fee is lower than a $35 Overdraft Item fee.

“Overdraft Protection transfers from your credit card will be cash advances under your credit card agreement and will accrue interest at the APR stated in your Credit Card Agreement. Please refer to your Credit Card Agreement for additional details.”

Posted by Sandrew | Report as abusive

Turns out my bank (USAA) has thought of this idea too (overdraft protection by linkage to credit card or savings account). Just waded through the particulars.

First, I can link it to any credit card I want, not just a USAA card, which is nice. The overdraft transfer is in increments of $100, and is treated as a cash advance on my credit card, which means I pay 3 points up-front on the advance, and accrue interest immediately (no grace period like for purchases) at my regular APR (let’s say 12% for simplicity). No other fees that I’ve found. So, worst case, a $101 overdraft ($200 advance) at the beginning of the billing period, left unpaid for 30 days, would result in $6 in fees (points) + $2 in financing charges (interest) for a whopping 8% all-in overdraft fee. The only other catch is that I have zero transparency into my cash advance limit (which they say is for “security and other reasons”). So if I sign up for overdraft protection with my credit card, even if I have plenty of available credit, they may still deny me the protection if I should need it.

All in all, not too shabby, though I could do without the points on the cash advance. I wonder whether BofA is thinking of this the same way, or if the Overdraft Protection Transfer Fee is something incremental to the cash advance fee. Anyone know?

Posted by Sandrew | Report as abusive

“On average in the industry, 85% of customers have NEVER had an overdraft transaction”

Well, a good part of that is because overdraft fees are horrific in the US. In the UK, I’d suspect that more than 85% of customers have had an overdraft transaction, and maybe a majority are regularly overdrawn. I’ve got a job that pays reasonably well (for a journo, anyway) and I’ve been overdrawn many times in the last year. Most students spend pretty much their entire academic career carrying an overdraft.

Basically, in the UK system an overdraft is a pre-arranged revolving credit facility with no minimum payment and with the limit determined by the bank based on your history of repayment and of course your regular income.

Posted by GingerYellow | Report as abusive
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