Opinion

Consumer Overdraft Concerns Highlight Need for Reform

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There was a time when banks rarely allowed customers to overdraw their accounts. Today, the practice of charging for overdrafts brings in billions of dollars in annual revenue. While overdraft fees are currently an issue only for checking account customers, prepaid card customers may soon be subject to similar charges unless the Consumer Financial Protection Bureau intervenes.

The Pew Charitable Trusts' survey research of checking account holders and prepaid card users demonstrates the need for new rules for both of these products. Banks should have transparent overdraft policies for checking accounts and charge reasonable fees, while prepaid cards should not offer overdraft loans at all. And both products should be free of the hidden fees that too often are the basis of overdraft programs. 

Pew asked 1804 consumers about their experiences and views on checking account overdraft policies in our recently released national survey. As in our 2012 survey on this topic, we found that most consumers do not understand the rules and bank policies that govern overdraft fees. For example, more than half of those who incurred a debit card overdraft penalty fee in the last year do not believe that they opted into overdraft service, as required by Federal Reserve rules implemented in 2010. We also found that overdraft products push consumers out of the banking system—28% of those surveyed report responding to overdraft fees by closing a checking account.

Our survey identified a number of overdraft practices that are ripe for reform. A majority of consumers (87%) are concerned about the high cost of overdraft penalties, and 78% are concerned about the practice of charging an extended overdraft fee if the overdraft and original fee are not quickly paid back. Consumers also object to the practice of reordering transactions from a high-to-low dollar amount, which has the effect of maximizing overdraft expenses by charging many fees on small purchases rather than one fee on a larger purchase. In addition, two-thirds of those who overdrew their accounts in the last year would rather have a transaction declined than pay a $35 fee and are strongly supportive of more overdraft regulation.

The fact that this survey's findings are not markedly different from our findings two years ago demonstrates the need for CFPB action to make this market fair and transparent. The CFPB has indicated that it is continuing to study checking account overdraft practices and will release its second report this fall.

The results of Pew's research on prepaid card users also underscore the need for regulation over prepaid cards. Focus group participants throughout the country tell us that their experiences with overdrafts are driving them to use prepaid cards. They like the control of a prepaid card because they can spend only what they have and avoid debt. These statements are supported by data from our February 2014 national survey of 613 prepaid card customers, which found that 59% of prepaid customers have a checking account and 29% previously had one. Of those who had or have a checking account, nearly two-thirds report paying an overdraft fee at least once. Furthermore, 41% of prepaid users say they have closed or lost a checking account because of these fees.

Prepaid cards are called “prepaid” for a reason. Rules should require that any credit be offered separately in order to avoid a repeat of the hardships caused by checking account overdrafts. An overdraft prohibition will ensure that use of prepaid cards can grow without forcing consumers to accept a product that they don’t want.

As for checking account overdraft practices, we are encouraged by changes in the marketplace that point to more manageable offerings for consumers. At the April meeting of the Federal Deposit Insurance Corp. Advisory Committee on Economic Inclusion, two banks showcased new checking account products that do not allow overdrafts. One bank’s representative stated that 3 to 4 million of the bank’s 70 million customers get into trouble with overdraft penalties, and said that bankers will point these customers to their new account which does not allow for overdrafts. Of course, marketing these products will be key to ensuring that overdraft-free accounts actually help consumers. If the banks do not make sure consumers know about this option, enrollment will be low.

The results of our research overwhelmingly show the need for new rules to govern overdrafts. Since prepaid cards are relatively new to the market and overdrafts are rarely offered, we urge the CFPB to ban this feature when it proposes rules for general purpose reloadable prepaid cards this summer. Overdraft practices are more entrenched in checking accounts, so we propose that the CFPB prohibit reordering of transactions that maximizes overdraft fees—and require that these fees be proportional to a bank’s costs to provide the loan.

The CFPB’s mission is to make markets for consumer financial products and services work for Americans. New overdraft rules will do just that.

This article was published by American Banker.

Susan Weinstock is the director of consumer banking research at The Pew Charitable Trusts.

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