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FOS Blog

20 Apr
2022

Overdraft Best Practices Are Changing

Overdraft Best Practices Are Changing

Over time, overdrafts have evolved from an occasional, courtesy event to automated programs generating millions in revenue. Consumers aren’t managing their checkbooks (if they even have them any longer) the way they once did.  Younger, lower-income, and non-white account holders are among those more likely to pay an overdraft penalty. Pew reported that 18% of the population pay 91% of overdraft fees. The most “heavy over-drafters” (incur over $100 in NSF fees annually) are Millennials or Gen Xers. This has caught the ire of regulators because consumers are being harmed.

What are those “harms”?
Checking accounts are being closed because of overdrafts, which in turn leads to an increase in unbanked populations. These consumers tends to prefer a declined transaction over a $35 fee. Banks should stop reordering transactions to maximize fees. It may also be time to change from a static to dynamic overdraft limit based on account-holder characteristics – age of the account, average balance, overdraft history, deposit amounts and frequency, other banking relationships.

Regulators are forcing changes in overdraft practices, if not by regulation, then by UDAP implication. The pressure started with large institutions. In a recent Pew Report, they noted that 5 of the country’s largest banks announced they were eliminating NSF (Nonsufficient Funds) and overdraft fees. Some are offering small dollar loans (less than $1,000), payable over 3 months.

Representments
The FDIC recently cited that multiple NSF fees for the same transaction could be an FTC UDAP (Unfair or Deceptive Acts or Practices) issue. They challenge that charging a separate NSF fee each time the same transaction is re-presented against a negative balance is unfair. They cited lawsuits beginning as early as 2018 as a breach of a bank’s deposit agreement. If your agreement states that an NSF fee could be charged “per item” or “per transaction, it should also provide further explanation that the same transaction might result in multiple NSF fees. Lookback periods in these cases have been for 1-5 years.

Representments pose an operational challenge for banks. How can you take preventive measures to not charge for representment? How do you identify representments to refund any additional NSF fees? This will require core system and overdraft software reprograming.

What to do?
What can a bank do while technology catches up?

Here are some things that we’ve identified:

  • Discuss your current practices and the potential risk with bank management and the board of directors.
  • Review your deposit agreement to make sure it reflects your operations.
  • Forgive fees for small negative balances (ex: Less than $50 or $100). Most overdrafts are for less than $100.
  • Adjust your overdraft and NSF fee structure – Reduce fees from ex: $35 to $10 per overdraft with a maximum of $30/day. Make the fee proportional to the overdraft amount. Manually limit fees to first-time presentment.
  • Use a real-time electronic alert system (email, text, online banking). Allow a 2-day grace period before assessing fees after the alert has generated.
  • Allow direct deposits to post 2 days before payday.

Because overdraft processing is largely automated today, find out what your core system and overdraft software vendors are doing to address processing.  What mechanical changes are necessary? How will you detect re-presentations including those through ACH?

Institutions will make revisions if they have taken advantage of overdraft fee income. For additional information contact the author edehmey@fosaudit.com.