Redefining Overdraft Protection in Credit Unions
By Cheryl Lawson, EVP-Compliance Review, ADVANTAGE
July 22, 2024
Overdraft protection is a contentious topic for most credit union leaders, and rightfully so. The Consumer Financial Protection Bureau’s (CFPB) scrutiny of overdraft programs has become a constant presence in this year’s events and meetings, both on the agenda and in the hallways. As we all eagerly await the CFPB ruling on overdraft fees, they face the complex task of balancing regulatory expectations, consumer needs, market competition, and the realities of service-based non-interest income.
The Regulatory Scrutiny
All regulators have increased their focus on overdraft protection. These entities are most concerned by financial institutions relying on overdraft fees as an income stream.
The CFPB has stated that to be exempt from the proposed rule, the fee must be tied directly to the cost of offering a “service” – the final rule may contain a benchmark fee as low as $3. The proposed rule reclassifies overdraft programs as a loan product subjected to Reg. Z.
However, the CFPB fails to note that the average overdraft fee is already declining. According to Bankrate’s research, published last August, the average overdraft fee dropped to $26.61, marking an 11% decrease from their 2022 study.
Overdraft services are at an all-time high for intense scrutiny. It’s a regulatory focus that demands immediate action.
The Time to Act Is Now
There is a strong need to maintain and evaluate overdraft programs to align with the rapidly changing landscape. Credit unions must introduce alternatives and provide members with options. Transfers from savings accounts and lines of credit and implementing fee caps are a few ways to reduce consumer costs and protect members from excessive charges.
Consumer Needs and Expectations
When examining overdraft programs, their intended purpose is often forgotten. It is not simply a way for credit unions to generate more revenue but to provide a financial safety net. Members value overdraft services for the financial flexibility they provide and often express appreciation for the coverage during shortfalls. Overdraft fees are usually less than a late fee on rent or a penalty fee plus interest for paying a bill late. Paying an overdraft over a late fee can save them hundreds of dollars. However, ensuring that these services are transparent and putting consumers first cannot be overstated.
Moreover, consumers should easily understand their options, especially the timing of payments. Credit unions can enhance the member experience by offering low-balance alerts, grace periods, and communicating alternatives to overdraft fees. This proactive approach fosters trust and helps consumers manage their finances more effectively. Overdraft programs should be a safety net, not a penalty.
This highlights the need to provide clear and comprehensive information about their overdraft programs and any potential alternatives.
The Overdraft Fee Dilemma
No one likes paying fees, but sometimes, they are necessary or unavoidable. It’s hard to ignore that overdraft fees represent a significant non-interest income stream for many community credit unions, and regulatory expectations coupled with market pressure threaten this income. The challenge lies in adapting fee strategies without compromising financial stability. No one is suggesting that overdraft fees should completely go away. However, the best response is to evaluate and adopt market-based fees, ensuring they remain competitive while aligning with industry standards.
A critical aspect of this adaptation is addressing the issue of excessive fees for those who frequently use overdraft services. Rather than removing the service, which could push them toward payday lenders, credit unions should offer additional options, including financial counseling, debt consolidation loans, and budgeting assistance. This holistic approach helps members manage their finances and reduce their dependence on overdraft services.
Technological Advancements
Technology plays a crucial role in modernizing overdraft programs. A more modernized payment system can enhance the efficiency and transparency of these services. For instance, digital solutions can provide real-time alerts and notifications so members can more easily be informed about their account status and avoid overdraft situations.
Technology investment allows credit unions to stay competitive and meet evolving consumer expectations. As the market becomes more saturated with financial technology options, offering seamless, consumer-friendly overdraft solutions becomes increasingly important.
Compliance and Risk Mitigation
Compliance is the cornerstone of effective banking and the foundation of overdraft program management. Overdraft programs must adhere to regulatory guidelines, such as those addressing multiple re-presentments and authorized positive, settle negative (AP/SN) transactions.
Keeping core systems and processes current to reflect regulatory requirements and best practices must be a top priority. Additionally, compliant disclosures are essential for regulatory adherence and overall consumer understanding. It is vital to address these compliance issues to mitigate the risk of regulatory penalties and class action lawsuits.
CFPB’s Benchmark Overdraft Fee Options
The CFPB’s introduction of benchmark overdraft fee options – 3, $6, $7, and $14 – has unsurprisingly raised questions within the industry. These benchmarks are intended as a guide, allowing financial institutions to adopt either one option or create their own based on defensible data. These benchmarks are not an end-all-be-all for overdraft fees.
The CFPB’s data is based on over a decade-old information from large, undisclosed overdraft providers. This data does not reflect the current environment or the transparent, consumer-focused solutions that many of the community credit unions we partner with offer.
Furthermore, these benchmarks may not apply to smaller financial institutions. For example, a bank with 600 million customers may have overdraft fees that cost three dollars, but this is not the case for every size institution. This shows that credit unions must leverage their current data to create benchmarks that accurately reflect operational costs and member needs.
While most financial institutions will not be directly impacted by the CFPB’s pending rule, credit unions, in particular, should remain mindful of market trends to keep the program and fees competitive. Regardless of the final rule, credit unions may still have to justify their program to examiners, ensuring they are up to regulatory standards and are providing a valuable service to those consumers who want it.
The Role of Examiners
The NCUA's 2024 Supervisory Priorities include an expanded review of credit unions’ overdraft programs, focusing on website advertising, balance calculation methods, and settlement processes. The agency also expressed concerns about overreliance on overdraft and NSF fees.
Overall, they have been vocal about addressing problematic overdraft programs, particularly those relying on systems that authorize positive and settle negative (AP/SN) or impose multiple re-presentment fees within a single day. Examiners aim to ensure credit unions provide transparent disclosures, manage negative accounts effectively, and help members understand how to avoid overdraft situations.
Conclusion
Overdraft protection is a multifaceted issue that requires balancing regulatory demands, consumer needs, and financial realities. Adopting a consumer-centric approach, leveraging technology, and maintaining compliance leads to effectively navigating this challenging landscape. The key lies in evolving overdraft practices to be fair, transparent, and supportive of consumers’ financial health, ensuring these services continue to provide value in a changing regulatory environment.
As the industry engages in discussions prompted by the CFPB’s proposal, it’s clear that stronger households create stronger communities and, by extension, stronger credit unions. The goal is to keep consumers out of predatory lending situations and provide them with reliable, transparent financial solutions.
Contact ADVANTAGE to learn more about how to receive a complimentary evaluation.
About ADVANTAGE
ADVANTAGE, powered by JMFA, is dedicated to empowering financial institutions with strategic solutions for growth and success. Our comprehensive services include overdraft program consulting and compliance, checking account acquisition strategies, contract negotiation expertise, and consulting for technology strategy, evaluation and selection. With a rich history of serving credit unions nationwide, we are committed to delivering exceptional value and fostering long-lasting partnerships. Choose ADVANTAGE, to elevate your performance, identify new opportunities, and build more value.