What went wrong?

 

How could something as simple as a checking account overdraft turn into a potential disaster for many banks and credit unions?

 

I’m talking about the predicted loss of billions of dollars in NSF fees as a result of the pending Reg E overdraft opt-in legislation bearing down on us.

 

All this could easily have been avoided had financial institutions simply required checking customers to also have a linked regular savings account.  Funds in the savings account would be transferred to the checking account to cover any overdrafts.

 

No savings account – no overdraft protection.

 

Insufficient funds in the savings account – no overdraft protection.

 

Banks and credit unions could set a reasonable fee for each transfer from savings to checking to cover overdrafts.

 

My credit union’s fee is currently a puny $3.  I’d happily pay $10 for the same protection…perhaps up to $12.  This is the price elasticity issue discussed in my March 3rd blog.

 

With the introduction of free checking around 1982, the average NSF fee was about $12.  And most customers were happy to pay it to prevent the embarrassment of an overdraft.

 

What went wrong is that somewhere in the 1980s, banks caught the fee fever and started looking for as many fee income opportunities as possible.

 

Overdrafts became a popular fee target as bankers have historically viewed overdrafts as a bad thing – careless behavior on the part of a portion of their checking customer base.

 

In fact, I remember in the 1980s when some banks terminated checking customers’ accounts if they had too many overdrafts during a 12-month period.  And many banks refused to open a new checking account for prospects with a history of overdrafts at prior financial institutions.

 

Fee fever changed all this.

 

Over the course of the last 25 years, overdrafts have become a major source of a bank’s and credit union’s fee revenue stream.

 

One positive outcome is the industry’s attitude towards customers’ overdraft behavior changed for the better.

 

For some customers, overdrafts are a function of an erratic income flow.  For others, it’s more of a life-style issue – they simply don’t keep track of their checking balance and are willing to pay a fee to avoid overdrafts.  Still other customers are infrequent users of overdraft protection and are glad it is available.  Some are high balance customers while others maintain low balances.  There simply isn’t a single profile of the typical overdraft user.

 

Every checking customer is a potential user of overdraft protection.

 

In their zeal to extract more fee income from overdraft users, financial institutions followed some combination of four paths:

 

1. Continued increasing the basic fee to the point where an average fee today is in the $35 range.
2. Reordered the daily processing of debits and credits to generate more fees.
3. Approved overdrafts resulting from ATM withdrawals and debit card activity at the point-of-sale.
4. Replaced simple overdraft protection programs like linked savings accounts and small unsecured lines of credit with sophisticated programs like Courtesy Pay.

 

Unfortunately, many financial institutions didn’t know when to stop increasing and assessing fees.  Once customers started screaming that a $2.50 overdraft on a coffee purchase ended up costing them over $150 in overdraft fees, the government stepped in.  The end result is the costly, forthcoming Reg E opt-in requirement.

 

It didn’t have to end this way.

 

On the other hand, it’s likely that the ultimate outcome of this opt-in requirement will be a return to more acceptable overdraft protection programs at most financial institutions.

 

Personally, my vote is for the linked savings account.  While I have no statistics to support it, I have to believe that a majority of checking customers also maintain a regular savings account for a variety of purposes.

 

Another option in lieu of a linked savings account would be either a linked credit card or a small, unsecured line of credit linked to checking.  I prefer the unsecured line of credit as many banks and credit unions are not issuers of credit cards.

 

Let’s face it, overdrafts are a fact-of-life in the banking business and, therefore, require a sensible business plan to accommodate them in a realistic manner that is acceptable to both the financial institution and its customers.

 

Think about this as you prepare your marketing plans for your opt-in notification program.