The Days of Automatic Overdraft Protection Are (Almost) Over

By Beth Longware Duff   

Public outrage fueled by exorbitant debit card overdraft fees has prompted the Federal Reserve Board to issue new rules prohibiting banks from charging fees for covering overdrafts on automated teller machine (ATM) and one-time debit card transactions unless the account holder agrees in advance to the service. The new regulations go into effect July 1, 2010.

Score one for American consumers. They spoke out loudly and forcefully, and the federal government listened and reacted. But the big question is: What will be the fallout for the people the rules are supposed to help?

Ironically, many cardholders stumbled into the overdraft trap because they believed the bank would automatically deny their ATM or debit transactions if there wasn't enough money in their account to cover them. Oftentimes, customers didn't know the bank had enrolled them in the service until the overdraft fees started popping up on their account.

The practice has meant big bucks for banks and credit unions. According to an October 2009 study by the non-profit Center for Responsible Lending (CRL), over 50 million Americans overdrew their checking account at least once over a 12-month period; more than half racked up five or more overdraft, or non-sufficient funds (NSF), fees.

In 2008 alone, banks and credit unions collected nearly $24 billion in overdraft fees, contributing to a 35-percent rise in their overdraft fee income between 2006 and 2008, CRL reports. Some estimates push that figure to $38 billion when fees for checks and electronic transactions not covered by the new rules are included.

"It is now standard practice for most banks and credit unions to automatically enroll checking account customers in their most expensive overdraft loan program — one in which the financial institution generally approves transactions when the accountholder does not have enough funds to cover them — in return for a fee of around $34 per overdraft," CRL stated.

Additionally, CRL noted several ways that banking institutions capitalize on overdrafts, including re-ordering transactions from largest to smallest to generate more fees, placing no limits on how many fees a customer can run up within a given period of time, and charging fees that don't reflect the institution's actual cost to cover the overdraft. In fact, previous CRL research had revealed that consumers paid about $2 for every $1 in credit extended if they overdrew their account using a debit card at a checkout counter.

"Overdraft fees can be costly," noted Governor Elizabeth A. Duke, who chairs the Federal Reserve Board's Committee on Consumer and Community Affairs. "Our rule will help consumers better understand the terms and conditions of overdraft services and will give them an opportunity to avoid fees when these services do not meet their needs."

While some consumer advocates criticize the new rules for not going far enough, banking industry executives counter that the restrictions go too far and will ultimately hurt consumers.

"I would suspect that many community banks will simply stop offering overdraft protection to avoid the costs and penalties of complying with the rule," Camden R. Fine, president of the Independent Community Bankers of America, told The New York Times. "If that happens, it will not be the banks that suffer as much as it will be the consumers and small businesses that have taken bounce protection for granted."

Before the new rules go into effect, consumers should familiarize themselves with the fine print. The regulations require financial institutions to provide a full explanation of their overdraft services, the fees involved, and the consumer's choices.

Specifically, the new rules apply to all customers, including existing account holders, and they must "affirmatively consent" to the overdraft service before any fees can be charged. Banks can't discriminate against customers who decline the overdraft service, and their account terms, conditions, and features must be the same as those of customers who opt in.

If a customer opts out, the bank or credit union cannot charge fees on any overdrafts that it pays on ATM and one-time debit card transactions. For those customers, banks are expected to return to their previous practice of declining transactions for insufficient funds.

It's also important to note that all customers have an ongoing right to revoke consent for, i.e., opt out of, overdraft protection.

Two of the biggest criticisms of the new regulations are that they don't limit how high overdraft fees can go or how often they can be applied. Both houses of Congress are reportedly working on legislation that would require the fees to be proportionately related to what the transaction actually costs the bank. They would also prevent banks from deliberately posting charges in a way that runs up the number of overdraft fees, and they'd cap the number of charges at six per year.

The final outcome of the Federal Reserve rules and Congressional legislation remains to be seen, so stay tuned!