Overdraft loans – along with the hefty and often surprising fees that come with them – affect families across the country. For many of those charged overdraft fees, the market is not working for them, even if they are happy a bank processed a transaction instead of declining it. Compared to credit cards and other forms of credit, overdraft lending is very expensive.
More than a half-century ago, overdraft began as an occasional convenience with a modest fee. Over the course of several decades, many of the nation’s largest banks morphed this market into a junk fee harvesting machine. That’s why the Consumer Financial Protection Bureau is taking action to close regulatory loopholes that will bring long overdue transparency and competition for overdraft lending.
Abuses by Large Banks
Because overdraft lending is so profitable, we have seen how large banks have egregiously crossed the boundaries of the law. Seven years ago, the CFPB sued TCF Bank – now known as Huntington Bank – for tricking consumers into costly overdraft lending. Over the course of many years, TCF went all in to drive up its junk fee haul, including by cheating to get its customers to sign up for overdraft. Their efforts to churn hefty fees were so successful that the bank’s CEO named his boat “Overdraft.”
Junk fees became a core part of the TCF’s management philosophy, where employees could even get bonuses and higher scores on their performance reviews when they signed customers up for overdraft. At one point, managers at larger branches could earn up to $7,000 in bonuses for driving overdraft activity. Later, certain regional managers instituted opt-in targets for branch employees. TCF staff had to achieve extremely high opt-in rates of 80 percent or higher for all new accounts. The result was tricks, traps, and bullying that resulted in an overdraft opt-in rate that was triple the rate at other banks.
TCF was part of a broader trend – big banks using a lending rule carveout to build business models that root for customers to run out of money in order to extract more fees from them, with some even resorting to egregiously violate the law.
This was not an isolated incident. In 2015, the CFPB ordered Regions Bank to pay more than $56 million in penalties and redress for similar illegal overdraft conduct, which included charging overdraft fees even if the customers had never agreed to overdraft. Despite being subject to a law enforcement order, Regions didn’t stop. In 2022, the CFPB took action again against the repeat offender, ordering this large regional bank to pay $191 million for charging surprise overdraft fees. The bank charged overdraft fees even after telling consumers they had sufficient funds at the time of the transactions.
In 2022, the CFPB also ordered Wells Fargo to pay $3.7 billion for a slew of illegal conduct. Admittedly, it can be difficult to track Wells Fargo’s list of wrongdoing over the past decade. But, in addition to creating fake accounts for unsuspecting customers, Wells Fargo charged illegal surprise overdraft fees on transactions for which the customers had enough money in their accounts.
In the last several years, misconduct in the market has led the CFPB to take many enforcement and supervisory actions against large banks for illegal overdraft activity.
That’s why the CFPB is proposing a rule that would establish bright lines and ensure consumers know what they are getting when it comes to overdraft loans. Right now, overdraft lending is one of the only types of loans where consumers are not told an APR or given lending disclosures.
If finalized, the rule would close a loophole in the rules implementing the Truth in Lending Act that has allowed banks to lend money to consumers to cover overdrawn accounts without having to worry about the consumer protections that govern other forms of consumer credit. By closing the loophole, we are not shutting banks from profits or consumers from credit. Overdraft loans will simply have to play by the rules.
From Occasional Convenience to Junk Fee
But let’s look even further back at history. After a slew of lending abuses in the middle of the twentieth century, Congress passed the Truth in Lending Act in 1968, which applied to all sorts of consumer loans. The act protects consumers from behavior common at the time: “false or misleading advertising, bait-and-switch sales tactics,” and practices designed to increase the risk of default and repossession.1
Congress charged the Federal Reserve Board with implementing regulations for the new Truth in Lending Act. The Fed decided to exempt overdrafts from the requirements. Decades ago, a significant amount of payments and billing occurred through hand-written checks sent through the U.S. Postal Service. This created some unpredictability about when people would receive checks. As an occasional and case-by-case convenience, when an overdraft occurred, some banks cleared those checks for a modest fee, rather than letting large payments bounce.
The exemption meant that banks did not have to treat these overdraft loans as a consumer credit product, which would normally involve disclosures to facilitate comparison shopping and other protections.
But a lot has changed. After the exemption was created, automation increased and debit card transactions grew in volume, triggering many more overdrafts. Banks also increased the size of overdraft fees even as it got cheaper to process payments, turning overdraft into a significant profit maker. Large banks now typically charge $35 for an overdraft loan today, even though most consumers’ debit card overdrafts are for less than $26 and are repaid within three days—translating to an APR of roughly 16,000 percent. And today, only a very small portion of overdrafts are caused by checks.
Consumers have paid an estimated $280 billion in overdraft fees over the past two decades, including roughly $9 billion in 2022.
Because these loans are extremely profitable, many financial giants have sought ways to ratchet up revenues from their deposit account customers. This has required regulators to invest substantial resources to prevent illegal activity that inhibited fair competition.
CFPB’s Proposed Overdraft Lending Rule
That is why the CFPB is looking to close this longstanding loophole. Under the proposed rule, large financial institutions would need to treat overdraft loans just like credit cards and other lending products. For example, financial institutions could offer a line of credit linked to a customer’s checking account and debit card. The proposed rule provides clear provisions for banks that offer credit features linked to debit card products, which will even help many of them compete with credit card issuers.
In terms of the exemption, the CFPB proposes to limit the exemption to when a financial institution is simply recovering their costs. The CFPB is seeking comments on whether to give banks the option to charge a prescribed benchmark that doesn’t require them to do their own math. We are proposing a benchmark of $3, $6, $7, or $14. Banks would be able to charge more if they calculate a breakeven fee above the benchmark. We are also seeking comment on whether to get rid of the exemption altogether.
The proposed rule would cover the nation’s very large banks and credit unions that have $10 billion or more in assets. These financial institutions control most of today’s consumer deposit and overdraft lending markets. Regulators consistently identify the largest banks as pushing or crossing the boundaries when it comes to overdraft.
Right now, overdraft fees are often assessed for reasons people do not expect or understand, chip away at needed income, and take a heavy toll on families living paycheck to paycheck. According to some data, these fees can drive people to leave the banking system altogether and limit their ability to get ahead financially.
In the past few years, large banks have made several reforms to their approach to overdraft. I hope our proposed rule can solidify these gains and provide clear rules of the road that will halt further abuses.