U.S. Banks Watchdog Raises Questions About Overdraft Policies

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The overdraft feature provided by the country’s biggest banks to their account holders remain in the cross-hairs of the Consumer Financial Protection Bureau (CFPB), with the financial regulator claiming in a recent report that customers opting for this feature are at a higher risk compared to those who steer clear of it. [1] As overdraft fees are an important source of revenue for the banks, they often market the functionality heavily to their customers as protection for situations, when they have insufficient funds in their account to complete a transaction – be it the clearance of a check, purchase at a merchant or even cash withdrawal at an ATM. But customers who sign-up for this “protection” end up paying rather hefty overdraft fees.

The CFPB started digging deep into banks’ overdraft practices last February after various control measures it imposed on the service did not help lower the overdraft fees pocketed by the banks (see Overdraft Fees Reexamined Following Banks’ Bumper Results). Continued pressure on the banks in this area from the regulator is likely to result in two implications for the banks. Firstly, banks will have to loosen their overdraft policies further in the near future, and hence, forego more fee revenues in the time to come. And secondly, banks like Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC), who are yet to settle overdraft-related lawsuits will be forced to resolve their legal overhang faster.

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Overdraft practices and fees by banks have been a topic of considerable deliberation over the last few years, since it was determined that the banks wrongly made millions each year by charging hefty overdraft fees. A total of 29 banks faced lawsuits for allegedly rearranging debit card transactions to process the largest transactions first, so that the customer incurs more overdraft fees (a larger transaction would put a customer’s account below zero faster, so overdraft fees would be charged on a greater number of transactions). [2] The banks also did not notify customers using a debit card at a merchant outlet that the particular transaction would entail an overdraft.

Over the years, a large number of these banks have resolved the respective lawsuits against them with Bank of America (NYSE:BAC) footing the largest bill of $410 million among banks who have settled (see Bank of America Settles Debit-Card Overdraft Lawsuit). JPMorgan Chase (NYSE:JPM) settled early last year for $110 million (see JPMorgan Gets a Bargain in Overdraft Settlement Deal) and U.S. Bancorp (NYSE:USB) was the last big-wig to settle last July for $55 million (see U.S. Bancorp Settles Overdraft Lawsuit For $55 Million). Quite a few of the banks are yet to settle the overdraft charges – Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) featuring prominently on this list.

In response to the abusive overdraft practices, the CFPB mandated a series of controls for the banks, which were largely implemented by the end of 2011. But the effectiveness of these measures was questioned when it was reported early last year that banks earned $31.6 billion in overdraft fees in 2011 – not much lower than the $33.1 billion in 2010. [3] As a result, the regulator started a review of the disparity in overdraft fees among banks and also began looking for indications that the banks are wrongly getting customers to sign up for overdraft facilities by advertising the service inappropriately.

The CFPB’s pursuit of the issue is clearly not very good news for banks who are already struggling to make up for the loss in revenues from limits imposed on debit card fees. Further clampdown on overdraft fees presents a sizable downside to the fee revenue generated by their retail banking operations. You can understand how lower fee revenues impacts the value of Citigroup’s stock by making changes to the chart below.

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Notes:
  1. CFPB report raises concerns about impact of overdraft practices on consumers, CFPB Press Releases, Jun 11 2013 []
  2. Excessive Bank Overdraft Fee Lawsuits, Bank-Overdraft []
  3. Nine U.S. Banks Said to be Examined on Overdraft Fees, Bloomberg, Apr 20 2012 []