GUEST POST: Changes to Overdraft Programs Make Checking Accounts a Safer Option, But Abuses Remain

Leslie Parrish is a Senior Researcher at the Center for Responsible Lending.

The FDIC recently found that 8% of households—and about one-fifth of households of color—are “unbanked,” meaning they lack an account with a mainstream financial institution, such as a bank or credit union. Opening an account is an important first step in the asset building process—one which can lead to getting a car or home loan, developing savings for a rainy day, and saving for long-term goals like college and retirement.

With free checking accounts offered at most banks, and efforts such as “Bank On” initiatives in many states and localities helping families in communities across America access accounts, why do households remain unbanked, preferring to rely on expensive check-cashing outlets for their financial needs?

One leading reason is the increasingly aggressive overdraft policies of many banks, which collect nearly $24 billion a year in overdraft fees. While advertising “free checking,” banks and credit unions have been charging customers overdraft fees averaging $34 per incident even for small debit card transactions, which are the most common cause of overdrafts. These fees can add up quickly: An accountholder using a debit card for a series of transactions can rack up hundreds of dollars in overdraft fees in one afternoon, only to then incur additional “sustained” overdraft fees if they cannot repay this debt in a few days. That’s why those who overdraft most frequently find that “free checking” is a myth—the FDIC found that these accountholders are paying $1600 in overdraft fees every year.

The Federal Reserve has taken a step toward making checking accounts a safer choice for low and moderate income families. Starting August 15^th, banks will no longer be able to charge overdraft fees on debit card transactions unless the customer consents, or opts-in, to this type of overdraft coverage. Refusing to consent to this high-cost credit will enable consumers to ensure they only spend what they have while using their debit card, and avoid costly overdraft fees that can mire them in debt. (This choice has been available since July 1 to new customers at account opening.) Some banks—including the largest debit card issuer in the country, Bank of America—are getting rid of debit card overdraft fees altogether, citing customer preferences. Many financial institutions, however, are taking a different approach: using high pressure and often misleading tactics in an attempt to convince accountholders (and especially those who are among the most financially vulnerable and therefore the largest generator of fees) to opt-in.

Yet, other abusive overdraft practices remain a barrier to safe checking products. Overdraft fees bear no relationship to the cost and risk an institution incurs by covering a transaction; rather, banks charge a flat fee regardless of the amount of credit extended. This results in consumers’ paying about $2 for every dollar in overdraft coverage on a debit card transaction. In addition, financial institutions can continue to charge a limitless number of fees without ever having to offer a customer a more reasonably priced overdraft option such as a line of credit and continue to reorder transactions from largest to smallest to generate more overdraft incidents and thus more fees.

Existing regulators and the soon-to-be created Bureau of Consumer Financial Protection must ensure that overdraft loans, and all small dollar loan products, are extended on fair and reasonable terms—terms borrowers can afford so that they are more likely to promote asset building than to trap borrowers in debt.  Banks—and those who oversee them—can and should make these reforms a priority if they hope to encourage the unbanked to become part of the financial mainstream.