Today, the Consumer Financial Protection Bureau is publishing two research reports on checking account overdraft fees. The reports show banks, including big banks, continue to rely on these fees as a major source of revenue. Rather than competing on transparent, upfront pricing, large financial institutions are still hooked on exploitative junk fees that can quickly drain a family’s bank account.
One report we are publishing today shows that overdraft fee revenue continued a steady rise across the industry, toward $15.5 billion in 2019. It shows that overdraft charges continue to dwarf other sources of fees, like account maintenance and ATM fees. The second report shows that while these programs are less common among small banks and credit unions than they are for their larger competitors, consumer outcomes are similar across institutions. And while some new companies have come up with alternative models that shy away from these practices, heavy overdraft fees are still extremely prevalent across retail banking.
In a fair and competitive market, banks would transparently compete on rates and fees, building customer loyalty on service and trust. Consumers would choose a financial institution based on what works for them. Do their fees seem reasonable and predictable? Are their services a good match? And, importantly, if the consumer wanted to switch because they weren’t getting what they wanted, it would be easy.
But when it comes to bank accounts in the U.S., we don’t have a fair and competitive market. Rather than earning interest, many American families end up paying large banks for the privilege of holding their money. The main way banks have flipped the script from paying depositors to charging them is through deposit account service charges, like overdraft fees.
An overdraft occurs when consumers lack the funds in their account to cover a transaction, but the bank pays it anyway. This gives consumers access to funds, but at a cost. Most financial institutions charge a fee, typically around $34, for this service. When borrowing small amounts for only a day or two, this can be like paying an APR of more than 10,000 percent.
To fully appreciate how the market got so broken, it’s important to understand the history. Let’s start with the basics.
The federal government and states charter banks to collect deposits and then lend out that money in the form of loans to businesses and families. Banks charge interest to borrowers and pay interest to depositors, making money on the difference between the two. Over time, however, banks figured out how to make even more money off depositors for the “privilege” of holding their money. Rather than compete on the highest interest rate to attract customers, our nation’s largest banks now provide hardly any interest on deposits and charge billions in fees.
For example, even though it costs little for a bank to reject a debit when an accountholder has insufficient funds, many banks still impose a hefty fine, sometimes referred to as an “insufficient” or “nonsufficient” funds fee.
But the big pot of money that banks have created with deposit and savings accounts is with overdrafts.
Decades ago, when most people paid their bills through a check in the mail, bank regulators created a general exemption for banks offering something called “overdraft.” The idea of overdraft was created in the spirit of convenience, allowing banks to cover the customer who inadvertently put a check in the mail too early.
But over the years with the advance of debit cards, these overdraft fees became big money-makers. They became the reliable, bread and butter sources of revenue for many retail banks.
Overdraft sounds simple but it’s not. To correctly predict overdraft fees, customers would need to master the intricacies of a broken payments system. Believe it or not, many large banks today penalize their own customers based on things outside their control like the difference between authorization and settlement, the significance of the timing gap between the two, the amount of time a credit may take to show up in the account, the use of one kind of balance over another for fee calculation purposes, or the order of transaction processing across different types of credit and debits. It’s complex – and differs from institution to institution. Banks think they can get away with hitting their customers with these kinds of junk fees because such back-end pricing stubbornly resists the normal dynamics of a competitive free market. Even a savvy customer trying to shop for the best checking account would have a hard time parsing it all because she’d have to know the unknowable.
So let me be clear today: Upfront pricing that appears to be “free,” but is offset by opportunistic penalties that take advantage of complex rules and captive customers is not the sign of a competitive market.
The families who are getting hit hardest with these complicated charges are often the ones who can least afford them. Previous CFPB studies have shown that under 9 percent of account holders have more than 10 overdrafts annually and pay close to 80 percent of overdraft revenue. Because overdraft heavily impacts many consumers who are already struggling to stay afloat, it can drive them into involuntary account closures—and deeper and deeper into debt.
While many relationship banks and credit unions, as well as startups, have charted a different business model that isn’t dependent on exploitative penalties, it isn’t easy for them to chip away at the chokehold that large banks have over our checking accounts, since it can be a massive headache for a consumer to take their business elsewhere. The market will not solve this on its own. As our reports show, by and large – even during the pandemic – practices continued. For many big banks, overdraft fees are still the steady, reliable, predictable, easy revenue that shareholders love. Indeed, the big banks harvested billions – billions – in overdraft fees off Americans during the pandemic.
We have a clear market failure here. Congress has charged the CFPB with ensuring that markets for consumer financial products are fair, transparent, and competitive. To that end, the CFPB will be enhancing its scrutiny of banks that are heavily dependent on overdraft fees.
First, the CFPB will take action against large financial institutions whose overdraft practices violate the law. In investigating, the CFPB will also seek to uncover the individuals who directed any illegal conduct. The CFPB is also considering additional policy guidance outlining unlawful practices. Law-abiding institutions should not be disadvantaged by these practices.
Second, I’ve asked the CFPB’s bank examiners to prioritize examinations of banks that are heavily reliant on overdraft. Financial institutions that have a higher share of frequent overdrafters or a higher average fee burden for overdrafting should expect us to be paying them close supervisory attention. Ultimately, we plan to inform institutions on where they stand relative to their peers with overdraft. We believe sharing that information will increase transparency and help against the race to the bottom we have seen in this market.
Third, the CFPB will be looking to harness technology in ways that give American families the power to more easily fire poor-performing banks. We can only accrue the benefits of competition if customers can vote with their feet. Unfortunately, switching bank accounts isn’t easy. It involves new account numbers, new debit cards, updating direct deposit, updating auto-debits, and much more. If America can shift to an open banking infrastructure, it will be harder for banks to trap customers into an account for the purpose of fee harvesting.
Despite the findings in our research that banks are still dependent on overdraft, we know that banks understand that they need to kick this addiction. In fact, one large bank just announced that they will be eliminating overdraft fees. Many in the market are anticipating that other large banks will also call it quits. The CFPB is not holding out hope that this will happen quickly, so we will be considering a range of regulatory interventions to help restore meaningful competition in this market, rather than allowing large institutions to rely on junk fees forever.
The bottom line is that we will make sure that this market is upfront, not underhanded. The last quarter was a blockbuster quarter for banks, taking in $69 billion in net income. Consumers are handing over billions of dollars of their hard-earned money in these fees, even during a pandemic. By promoting a well-functioning market, American families can save billions and law-abiding banks can thrive.