Addressing the Impact of Overdraft Policies on Low-Income and Young Consumers
December 27, 2012
December 27, 2012
By John M. Floyd, President and CEO of John M. Floyd and Associates
In conjunction with Washington D.C.-based Morrison Foerster LLP, we at John M. Floyd and Associates (JMFA) have been working to provide the Consumer Financial Protection Bureau (CFPB) with a balanced look at how transparent overdraft programs can benefit informed account holders. Our findings, based on a series of overdraft policy information forums and surveys—involving more than 50 credit unions and banks—identified details related to patterns of overdraft use and how account holders are affected by practices and factors that the CFPB has identified as concerning.
Addressing the impact on low-income and young consumers
Although some may view the frequent tendency to overdraft as a lack of financial sophistication or even lack of judgment, it is important to remember that many Americans live from paycheck to paycheck and rely on liquidity from credit cards to accommodate unexpected expenses – or merely to make it until the next paycheck. A majority of the institutions we spoke to agree with the FDIC’s position that most regular overdrafters were disproportionately low and moderate income and more likely to be young adults. However, they noted that some middle- and high-income account holders are also regular overdraft users.
All institutions participating in the Overdraft Privilege program have policies and procedures specifically designed to manage the risk associated with regular overdraft users. This includes requiring all accounts to be brought current – including the payment of outstanding fees –within 30 to 45 days of incurring any negative account balance. And while individual policies vary from institution to institution, efforts to communicate with account holders carrying negative balances include letters and phone calls to inform them of the situation and encourage them to make a deposit.
In addition to these formal policies, most of the institutions participating in our study typically counsel regular overdrafters about how to avoid overdraft fees, and provide advice on how to balance a check book and establish a budget. However, many participants report that account holders are often offended by such outreach efforts and indicate that they are aware of the costs associated with using overdraft services.
Measuring the effectiveness of alternative services
Under the Overdraft Privilege program account holders are informed of alternatives to overdraft service programs; however, the number of account holders who use such services is relatively limited. More specifically, based on survey data, 82 percent of the institutions responding to our survey offer their account holders some sort of alternative to overdraft services at the time of account opening, and 57 percent provided reminders of such alternatives. In terms of using alternatives, survey respondents indicated that 27 percent of accounts are linked to a savings account, seven percent are linked to an overdraft line of credit, and seven percent are linked to a credit card account.
Notwithstanding the availability of such alternatives, institutions reported that only a very small percentage of regular overdraft users use these alternatives because they either do not have a savings account or do not have access to additional credit. Institutions explained that of the small number of users with available funds in their savings accounts, some have expressed concern about dipping into their savings.
With respect to credit, it appears that most users do not qualify for unsecured credit, do not have access to a line of credit or have no available credit on an existing line of credit. Institutions noted that even the small number of overdraft users who would qualify for a line of credit usually have declined the option of linking overdrafts to that type of alternative because they would prefer to avoid another credit obligation that would ultimately lead to a larger debt burden.
Most institutions agreed that, due to compliance costs and account management concerns, offering a more conventional small-dollar loan product was not economically feasible. In addition, some institutions explained that account holders were offended by, or skeptical of, the offering of such alternative products.
Also, efforts to encourage regular overdraft users to reduce their overdraft fees by engaging in fewer transactions that would result in overdrafts – such as drawing a single larger check or making a single large ATM withdrawal instead of small transactions – resulted in limited success in changing behavior.
How efforts to curb fees could impact regular overdraft users
Legislation being considered by Congress would address the issue of regular overdraft users by limiting overdraft fees to one per month and six per year, and require that fees be reasonable and proportional to the amount of the overdraft. However, we believe that limiting the number of overdraft fees that can be charged will result in overdraft services being unavailable to account holders who need the service the most.
The institutions we surveyed spend a significant amount of time, and attendant expense, working with these account holders. Although the posting of overdrafts to accounts is relatively inexpensive, the monitoring of overdrawn accounts, including collection letters and other communications with account holders, is costly. They believe that the liquidity needs of regular overdraft users likely will not be met if the number of overdraft fees is limited as proposed.
This could force many account holders to make less attractive choices to meet their liquidity needs, including deferring payment on bills and resorting to payday lenders. In this regard, a number of institutions that we interviewed reported that offering overdraft services reduced their account holders’ reliance on payday lenders, and noted that this observation was based on tracking payments made by account holders to payday lenders.
At the conclusion of the Forum study, we provided the CFPB with our findings. Based on input from participating institutions and more than three decades of providing fully compliant overdraft services, we believe that overdraft programs provide a valuable service to consumers who need help managing their finances during emergencies or due to unforeseen circumstances.
And while there continues to be uncertainty regarding regulation of overdraft programs, we believe that full disclosure, informed choice and fair treatment are critical to effective program usage.
JMFA is a leading provider of profitability and performance-improvement consulting. For more than 30 years, JMFA has been recognized as one of the most trusted names in the industry, helping financial institutions enhance their bottom line with programs like JMFA Overdraft Privilege®. JMFA is also recognized for earnings enhancement and expense control programs, training, executive placement, account acquisition programs as well as product, service, pricing and technology-improvement consulting. Simply stated, JMFA’s programs and services are designed to increase income or reduce expenses. JMFA is proud to be a preferred provider among many industry groups. To learn more about JMFA, please call 800.809.2307, or visit our website at www.JMFA.com.
Strategic Link is the NWCUA’s wholly-owned service corporation, providing the Association’s member credit unions with exclusive high-quality, competitively-priced products and discounted services. To learn more about how the Association’s partnership with John M. Floyd and Associates can benefit your credit union, contact Director of Strategic Partnerships Craig Reed: 206.340.4789, email@example.com.