CFPB Ruling on Overdraft Fees: What It Means for You
Today, I read an article on CNBC talking about how the CFPB announced a new rule that limits how much banks can charge for overdraft fees. They cite a current average fee of $35, which is in line with what I’ve experienced in my professional life at 3 different banks. The CFPB has been targeting this for a while. Biden’s Administration has also been targeting this one as part of their war against “junk fees.” On the surface, this seems like a really good idea for bank customers. However, I want to take a slightly deeper dive into this idea by exploring the bank’s perspective of overdraft fees, and I’ll also conjecture how I think banks will respond.
First, why do banks charge overdraft fees? The consumer would say it’s to kick them while they’re down. I heard one comedian say, “You’re charging me money for not having any money? That’s why I didn’t have money in the first place! I would love to have more money in your bank!” As satirical as those comments can be, there is more to it from the bank’s perspective than you might realize.
I’m not going to suggest banks don’t make money with overdraft fees—they do. It is a major revenue driver for banks. Here is how your bank would respond to why they charge those fees at all.
1) It’s an interest-free loan to you. Normally, when you get a loan, it requires an application and underwriting process. With overdrafts, your bank lends you money by skipping that process. It’s viewed as a loan because they are giving you money that you need to pay back. This is the only loan they offer that doesn’t carry an interest charge. So, adding a fee is the compromise for being interest-free.
2) It beats the alternative. What I mean is that if you try to: pay a power bill, buy groceries, pay your mechanic, pay your mortgage, etc., getting an overdraft fee is still a better scenario than what happens if any of these types of transactions don’t get paid. You risk not having power, groceries, your car, or a place to live. Does that sound extreme? Perhaps, but it isn’t impossible. It isn’t out of the question that missing a mortgage payment would have greater financial fallout for you than paying an overdraft fee. So, in essence, the bank is helping you out. Now, banks also charge overdraft fees if you buy a coke with a negative balance in your account. Does the fee beat the alternative here? I’m thinking most people would rather miss out on a coke than pay $40 for it. But bank systems can’t differentiate every single transaction on a case-by-case basis for all of their customers, so they tend to pay all of your overdrafts up to a limit. The predetermined limit is what cuts off the fees, not what you’re buying. Banks view this as a service that helps the customers more so than not paying your transactions.
3) It discourages abuses of the banking system. Would you believe me if I told you that there are entire groups of people that figure out the best ways to scam banks, and that they regularly share their knowledge with others? I used to work at a bank that was located inside a hospital. There was an entire department of employees at the hospital who knew exactly how much they could overdraft their account after each paycheck, and they would max it out each time. Then, whenever a new employee was hired in that department, that person would open an account with me and magically know how to abuse the system the exact same way! They knew how to work the ATMs at the ideal time; they knew how to work mobile deposits in their favor, and they knew what their limit was even though the bank never told them. They were teaching each other how to do it. I was shocked to learn how many people spent each and every month at a negative balance, ignoring the buildup of overdraft fees. Then, when the bank charged off the account, they would have to sue the customer over the $400-$1500 negative balance they were typically left with. The bank wants no part of that type of organized abuse. Overdraft fees discourage this. The fees don’t prevent this type of behavior, but they do discourage it. If there were no overdraft fees, the number of people who stayed in a negative balance would increase exponentially. If that happened, the banks would have to pay A LOT more attorney and court fees.
Now, onto my next point I hope to make in this post: how will the banks respond?
I commonly tell customers, “The house always wins.” That expression can certainly be applied in this situation. Why? Because history tells us that whenever the CFPB comes after a bank’s source of income, the banks will make up for it somewhere else. A few years ago, a new rule limited how much banks could charge customers to swipe their debit cards(the customers didn’t see this fee, it was built-in). Did the banks just rollover and say, “Oh well, I guess we’ll miss out on all that income we used to make.” NOPE! You saw free checking accounts disappear afterwards. If one area of the balance sheet takes a hit, then another area needs to make it up.
In this case, overdraft fees are a major source of income for banks. Do you think they’ll simply live with losing that income? Do you know how publicly traded for-profit companies work? Banks have investors, investors want a return on their money, and banks will find a way to adjust. Banks need to turn a profit, and they’ll do it.
Do I know what that will look like? Unfortunately, no. I’m not in those boardroom meetings. I can, however, venture a guess or two. I think you may start seeing charges to order debit cards. When debit cards first rolled out, banks charged for them. Due to stiff competition, some banks started offering them for free and took customers as a result, so other banks followed. I believe we could see a return to charging for them. We could also see new charges on online banking. Another thought would be increasing interest rates on loans or charging for some other common bank transaction that has always been free.
Ultimately, I simply don’t know. But, like I said earlier, the house always wins. You can bet that banks won’t roll over on this one and give up that source of income. Does that make banks evil, greedy corporations? No, that’s simply how businesses in the free markets work. If you are a stockholder in any bank, you would want the same thing.
"true courage is about knowing not when to take an overdraft fee, but when to spare one." - gandalf
