Federal Reserve Issues New Rules for Debit Card Overdrafts

By Beth Longware Duff   

In November 2009, the Federal Reserve Board announced new rules for ATM and debit card transactions that should make many American consumers very thankful.

The rules, which were issued under the Electronic Fund Transfer Act and go into effect on July 1, 2010, prohibit banks from charging their customers overdraft fees on automated teller machine (ATM) withdrawals and one-time debit card purchases unless they've already opted into the service.

"Overdraft fees can be costly," said Governor Elizabeth A. Duke, the chair of the Board's Committee on Consumer and Community Affairs. "Our rules 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."

In order to opt into the overdraft service, customers must be provided a notice explaining the bank's overdraft services and any fees involved. It must also outline the customer's choices, including a model opt-in notice. Banks are also not allowed to treat customers who opt out any differently from those who opt in.

In announcing the changes, the Federal Reserve said that its own consumer testing revealed that most people would rather not be enrolled in overdraft services for ATM and non-recurring debit card transactions unless they've specifically agreed to such services ahead of time. However, the Fed's testing also revealed that most consumers do want overdraft services to cover important, recurring bills, such as payments for rent, utilities, and telephone service.

Debit cards have been a steady growth area for financial institutions in recent years, with the potential for even more expansion. The PULSE 2009 Debit Issuer Study revealed that debit card transactions were up eight percent in the second half of 2008. Additionally, debit card penetration in the United States — i.e., the percentage of eligible account holders who have a card — is 73 percent.

"In most cases, these transactions are replacing cash, highlighting a clear consumer preference for electronic payments," said PULSE Executive Vice President Cindy Ballard.

While debit cardholders may be happy with the new regulations, many financial institutions are not, mainly because they stand to lose significant income.

According to the research company Moebs Services, banks in the United States will collect a record $38.5 billion in overdraft fees this year, nearly double the $19.9 billion they collected in 2000. That figure could drop considerably under the new regulations.

Nearly all the overdraft revenue was paid by just 10 percent of customers, says Chief Executive Mike Moebs.

"Most people paying these fees have a credit score below 590 or so," Moebs elaborates. "Beyond that, they're a whole gamut of people: rich and poor, men and women."

Edward Yingling, chief executive of the American Bankers Association, predicted in The Washington Post that banks will find it difficult to replace that revenue, especially in light of additional new regulations enacted by the Credit CARD Act passed earlier this year. Some possible alternatives that the banks may choose to institute include charges for services that are currently free, including checking and no-minimum-balance accounts, he indicated.

Many consumer protection groups would prefer the new rules to cover all types of banking transactions, not just debit card overdrafts. Checks, which according to the Federal Deposit Insurance Corporation (FDIC) account for 30 percent of overdraft transactions, and regular electronic bill payments are not covered.

Ed Mierzwinski, program director for the consumer advocacy group U.S. PIRG, has gone on record as saying that the Fed "hasn't solved the bigger problem that once people opt in, it's still an unfair product that perpetuates debt."