Re-sequencing Debit Transactions Earn Banks Negative Attention, Profits, Record Penalties

When the Federal Reserve moved to protect bank customers from overdraft charges in 2010, consumer advocates hailed the move as a much-needed blow to the overdraft business that would end the fee cycle that Consumer Financial Protection Bureau (CFPB) Director Richard Cordray says has “the capacity to inflict serious economic harm on the people who can least afford it.”

The rule, known as Reg E, requires overdraft penalties on one-time debit card transactions and ATM withdrawals to be “opt-in.” However, the rates were still high and destined to go higher. Once fully implemented, the changes made little difference, as the average overdraft penalty has risen to $35, meaning an ill-timed lunch purchase can cost $40 instead of $5.

According to a law firm currently involved in litigation with banks over their overdraft policies, in 2011—one year after the rule was implemented—banks reaped $30 billion in fees from consumers. That figure is down from $40 billion in 2009 but is still easily enough to warrant continuing the business model.

According to a recent Pew Charitable Trust study, though, the lawsuits resulting from shady debit card overdraft fees that banks are happily settling without litigation could cost them at least a portion of their profits—about $1 billion. But is it enough to stop or even slow the rising penalty structure?

“Bankers have little reason to shed this highly profitable yet marginally-disclosed business practice,” said Northwest Credit Union Association (NWCUA) CEO John Annaloro. “Lack of disclosure may be the worse attribute of the non-sequential check processing charges. The recent settlements that have been reached are proof that many banks need to be penalized for seeking continued ways enrich themselves by tricking consumers.”

Recent headlines confirm this:

Admitting no wrongdoing, banks are agreeing to these settlements after a transaction re-sequencing policy designed to maximize profitable penalties from their customers was exposed. In this controversial practice, debit card transactions are processed at the end of the day in order from the highest amount to lowest amount, rather than in the chronological order in which the transactions occurred. By depleting the customers’ accounts with the largest transaction first, banks are more often able to charge overdraft penalties to the remainder of the transactions, potentially collecting multiple times what could have been a single overdraft penalty.

Financial institutions that have adopted this practice without adherence to new rules, opt-in provisions or clear disclosures to customers are risking two things: money and reputation.

“Sadly, banking’s wrongdoings may continue until the fines and penalties banks pay are equal to the profits they gain by bending regulatory rules or engaging in deceptive consumer practices,” Annaloro said.

But what is par for the course for banks also represents another example of the reason credit unions came into existence in the United States more than 100 years ago. It’s also why credit unions are encouraged to stay far away from the re-sequencing policies that are creating further costs for banks, according to NWCUA Director of Compliance Services Mary Sroufe.

Model policies relating to debit cards and overdraft are available on the NWCUA’s Infosight resource here and here. In the context of the hundreds of millions of dollars in settlements that banks have been agreeing to lately, the simplest ways to avoid litigation are to post one-time debit transactions in chronological order or to completely abstain from issuing debit cards altogether, a policy that Seattle’s Northwest Baptist Federal Credit Union has maintained.

“We don’t issue share drafts, and therefore don’t need written policies on the subject,” said Northwest Baptist President and CEO Robert Coleman. “But if we did, the policy that most benefits members and puts them first is what we would adopt.”

While Northwest Baptist’s stance is admirable, it is hardly an option for most of the 200 or so credit unions in Oregon and Washington. Instead, a compromise that some credit unions have adopted, including Cascade Community Credit Union in Roseburg, Ore., is to simply not process a transaction if the member has insufficient funds in their account—a policy that avoids Reg E and its required opt-in, and also saves the member money because no penalty is administered on one-time debit transactions. In the case of a force-post transaction, such as a fuel purchase, which results in the member overdrawing his or her account, no insufficient funds penalty is added, so no disclosures or opt-ins are required.

However, a negative aspect to this policy cited during Reg E’s implementation is the embarrassment a consumer might feel when their transaction is denied at the point of sale.

Sroufe suggests that a consumer-friendly policy for a financial institution interested in minimizing penalties and fees to their customers to consider is to sequence non-recurring debit transactions from lowest to highest. This type of member-first process is practiced at Express Credit Union, a Seattle-based institution whose mission is to provide affordable financial services to low- and moderate-income people in King County in order to help them build assets and achieve financial stability.

According to Express Credit Union CEO Sharon Hall, the credit union always treats members as individuals, and each issue is looked at on a case-by-case basis.

“First, we will put through as many as we can get to avoid fees to the member,” Hall said. “So, if there are three transactions outstanding, we don’t pick the biggest and return the other two. Instead, we put through two transactions and deny the third. However, if we see a transaction for rent or something else significant, we put those through instead of the others. We also call the member to alert them of the issue.”

Sroufe explained that the most important piece of an overdraft fee policy, regardless of its exact structure, is transparency.

“However an overdraft policy is defined,” she said, “having full disclosure about the policy would be important in any potential hearing.”

While controversial, overdraft protection is a policy that millions of consumers opted into with the implementation of Reg E. Overdraft protection essentially links a debt card to a loan. So, rather than deny a transaction at the counter, the transaction is covered, and the consumer is generally issued a one-time fee as well as a subsequent APR.

Consumer advocates have labeled “overdraft protection” connected to one-time debit card transactions—a policy common throughout the financial services industry, including at credit unions—as a form of payday lending.

In addition, the Consumer Federation of America (CFA), a leader in the battle against usury payday lending practices, says almost two-thirds of banks pile on second or per-day fees if consumers do not repay overdrafts immediately.

The CFA’s annual survey examining overdraft fees and practices at the nation’s 14 largest banks points out that the highest cost for a $100 overdraft loan repaid in two-weeks, if computed like a closed-end payday loan, is 2,779-percent APR. The bank that previously held the record for the highest overdraft charge at 3,250-percent APR dropped its rate to 962 percent, according to the CFA.

Seeming to welcome record penalties with a habit of settling rather than litigating, banks have long been a target of consumer protection attorneys. But they are not the only type of financial institution currently being challenged on overdraft policies.

Eight credit unions in California, Illinois and Alabama have recently been named in suits identical to the one that the largest banks are currently settling. They are accused of deceptive business practices that involve the systematic manipulation and re-ordering of electronic debit transactions from the highest dollar amount to the lowest dollar amount in order to maximize the amount of overdraft fees collected, on top of several other specific legal complaints that include fraud, negligent misrepresentation, unjust enrichment, breach of fiduciary duty and violation of the Unfair Business Practices Act and Professions Code.

Most have denied the accusations. However, until a verdict or settlement is reached, each credit union will likely face costly legal expenses and damaged reputations—a situation best avoided.

“Credit unions have experienced accelerated growth in the past year. Public awareness and market share are up.  Much of this has come as a direct result of the striking differences between profit-maximizing banks and not-for-profit financial cooperatives,”  Annaloro said.  “Maintaining the consumer-first distinction is important to the ongoing advancement of credit unions.

“The last things the credit union community needs at this critical juncture would be to become lumped into the negative banker headlines. Regulators and consumer watchdogs look are actively looking for illegal or controversial banking practices. Remember to review all in-house regulatory policies and disclosures for compliance as well as other complexities that may cause a member to take issue.”


Questions? Contact the Compliance Hotline: 1.800.546.4465,

Posted in Compliance News.