Overdrafts. We’ve all heard of them; most of us have had them sneak up occasionally. When a customer does not maintain a sufficient balance to cover a transaction, financial institutions may honor it and charge a fee. Seems simple, right? We wish.
For those who don’t use overdraft protection for regular cash management, a rare overdraft may be an inconvenience, but not significant. Customers may take comfort knowing their bank or credit union has their back should they overspend or forget to move monies around. But overdraft privilege is just that, a privilege. It’s rarely free and comes with benefits and drawbacks. Let’s take a look at those as well as risk mitigation strategies for financial institutions to keep their customers happy and their operations and compliance functions sane.
Overdraft privilege program benefits
There are overdraft privilege benefits to both financial institutions and customers. The most obvious is the ability to provide a safety net for customers and establish goodwill. By honoring transactions, customers are able to avoid possible point of sale embarrassment, avoid costly merchant fees and incur minimal disruption to their routine. Banks and credit unions earn additional fee income by offering this service. Overdraft programs can go wrong, but that should not preclude financial institutions from offering them or charging fees. They simply need to understand the risks and mitigating strategies needed in order to maintain strong controls and consumer compliance.
Overdraft privilege program drawbacks
The Dodd-Frank Wall Street Reform and Consumer Protection Act changed the way financial institutions handle overdrafts. Under the Electronic Funds Transfer Act (Regulation E), customers must be able to opt in or out of overdraft protection and related fees for debit card and ATM transactions. This same process is not currently required for checks and ACH transactions, which are processed using share draft account numbers. But Regulation E is not the only one to watch. Several other regulations are involved in overdraft compliance, such as the Unfair Deceptive Abusive Acts or Practices Act (UDAAP) and the Truth in Savings Act (Regulation DD), which bring more potential scrutiny.
Other drawbacks are instances of program abuse and member inability to bring accounts current. In some cases, customers can’t cover the amount of the transaction which caused the overdraft, let alone the related fee. Some may find themselves in a cycle of using overdrafts to get them through until payday. This may also cause financial institutions to incur charge-offs and/or remove overdraft protections from certain customers. Banks and credit unions should inform their customers that the institution is not required to honor future transactions.
Overdraft privilege program action items
Banks and credit unions must establish clear policies and procedures to comply with applicable regulatory requirements and monitor overdraft use for abuse. Additionally, institutions must test policies, periodic statements and disclosures to ensure operational consistency and regulatory compliance. Management should ask:
- What are our policy limits on overdrafts?
- How do we track opt-ins and opt-outs? Through our core processing system or a manual method?
- Can members opt out of all overdraft protections?
- Do periodic statements list overdraft fees?
- How are we promoting our program? Are we encouraging members to incur overdrafts?
- Do customers understand there are fees involved?
- When are we charging off uncollected balances and is it within regulatory limits?
- Do we offer credit counseling services for frequent users of overdrafts?
Testing should include check-clearing procedures to ensure they’re structured to minimize overdrafts and related fees through the clearing order. Remember that under UDAAP, an act or practice does not have to violate a law to be considered unfair or deceptive.
Questions about your overdraft program? RKL has a team of financial industry compliance experts who can review policies and procedures and make recommendations. Contact your RKL advisor or reach out through the form below to get started.