TRACEY MILLS
Like ‘spare tire’
Are overdraft protection plans a real service to consumers, or just another way for banks to generate revenue?
Some overdraft services have come under fire recently from consumer advocates who describe them as high-interest, short-term loans in disguise, with all the trappings of predatory lending. Industry experts agree that banks and their customers should tread carefully when it comes to such programs. But they also agree that, if done correctly, such programs can save customers from the embarrassment and expense of returned checks – while padding the bottom line for banks.
“Used appropriately, overdraft privilege creates customer loyalty and retention and also contributes to the bank’s bottom line,” wrote Joe Gillen in a recent U.S. Banker magazine article. Gillen is founder of Pinnacle Financial Strategies, a leading provider of overdraft privilege products.
With overdraft protection, customers who previously might have been written off for one bad check can be retained as satisfied and profitable customers.
In traditional overdraft protection plans, a bank decides on an ad hoc basis whether to pay or return a check, based on its relationship with the customer. Another type uses software to automatically identify customers whose overdrafts can be covered, based on the customer’s tenure and loan relationship; this plan ensures equal treatment of all customers. Still other banks offer lines of credit, transfers between accounts, or advances on credit cards.
Other plans are provided to banks by third-party vendors for a fee. Some vendors can be pushy with overdraft protection programs, marketing them as a way for banks to make money, said Tracey Mills, senior manager of public relations for the American Bankers Association. And the variety of products available can create confusion.
“Banks have to weigh what they hear from vendors with what is best for their customers,” Mills said. “Sales pitches can be misleading.”
Some products add the amount of a customer’s overdraft protection to their true balance, misleading them as to the amount of money at their disposal. With other programs, computer software sets the overdraft limit based on an account’s size and activity, but neither the criteria nor the overdraft limit, which varies from month to month, are disclosed to the customer.
Because of these properties, some consumer advocates have called for overdraft payments to be considered extensions of credit, thereby falling under the requirements of the Truth in Lending Act. On March 28, the Federal Reserve System noted that such programs “vary from vendor to vendor and … in their implementation from institution to institution,” and announced that it would continue to gather information before making any decisions.
However, there are some great products that are popular with consumers, and the pressure is on banks to offer such programs to remain competitive, said Mills.
More than 1,500 financial institutions out of approximately 18,000 in the United States offer overdraft protection, and more are conducting studies considering them, according to John M. Floyd & Assoc., a 30-year-old financial institution consulting company based in Houston.
“With a soft economy persisting and lending activity off sharply, bankers are looking to non-interest income to strengthen their bottom lines. Overdrafts are, indeed, among consumer fees that bolster profitability,” stated JMFA Chief Executive Officer John M. Floyd in a recent opinion column.
‘Fair Return’
That’s one of the reasons Plymouth Savings Bank recently decided to offer a new overdraft protection plan, Safety Net Account Protection.
“We thought it would be a great tool for our customers,” said Louis Kruger, senior vice president of retail banking at Plymouth Savings. “We also looked at it from an income perspective. If the decisions are going to be more uniform, the end result, from an income perspective, is a slightly higher percentage than before. From a money-making perspective, we would have a little more income, and be handling these things a little better. And our customers would be a lot happier.”
Indeed, Plymouth Savings has already received a few grateful letters from customers whose overdrafts were covered, Kruger said. Existing customers recently were notified of the program’s availability in a letter from the bank.
Traditionally, many community banks have had to deal with non-sufficient funds – or NSF – transactions manually every morning, with the main concern being to avoid unnecessarily returning a check to a good customer. The overdraft software takes the decision-making out of the managers’ hands, providing more objectivity and better control for each NSF case.
Plymouth Savings qualified some account holders for a $500 overdraft limit by evaluating how long they have been with the bank, as well as their deposit routines. No new accounts enter the program until after about 60 to 90 consecutive days of regular account activity.
About 70 percent of the bank’s retail checking account customers have qualified and, after notification, have decided to participate in the SNAP program. Customers who misuse the program will receive a letter asking them to be a little more careful.
“We’re not advertising it. We don’t think it’s a product where we should go out there and say we have this,” Kruger said. “We just want to make sure we don’t give the impression to our customers that they should be using this all the time. It is an expensive situation for them.”
With overdraft protection, banks charge the same fee whether they pay or return checks. The national average is $22 per check.
Some observers have criticized such plans because banks make money from them. Banks may make $22, but then again, the customer didn’t have to pay additional handling or late fees to a merchant, or get on a bad-check list, industry experts point out.
“It’s like a spare tire. You don’t want to drive cross-country on it, but you want it in the car in case you need it. It’s a privilege,” said ABA’s Mills.
With proper disclosure and consumer education, consumers are given the power to make a conscious financial decision.
“If they make a mistake, there’s a safety net, and if they choose to use it on purpose, they can do that too, so the rent’s on time,” said Richard A. Miller, New England regional director of JMFA.
Mega-banks may have complicated overdraft systems difficult to disclose, and some of them have been criticized for that, Miller said. But disclosure should be easier, not harder, for big banks, according to Fleet Bank spokesman Jim Schepker.
“For larger, progressive banks, there are more channels to communicate messages to consumers,” Schepker said, citing Fleet’s Homelink online banking product and its 24-hour call centers. “Given today’s technology, it’s never been easier to avoid overdrawing your account.”
“We encourage anyone who walks into Fleet to apply for cash reserve, our overdraft protection product,” Schepker added.
At Fleet, a customer fills out a credit application, which becomes the basis for their individual overdraft limit. Once that credit line is in place, the funds are always available. If the account ever does overdraw, there are two fees: one is an automatic one-time annual activation fee of $24. Then any funds a customer uses from the cash reserve are subject to an 18 percent annual percentage rate.
Some customers with certain types of accounts don’t incur the $24 activation fee; these types of accounts are held by the majority of Fleet’s customers, Schepker said.
In a recent memo, ABA Chairman-elect C. Kendric Fergeson recommended conspicuous disclosure, especially of overdraft fees and the fact that the bank is not promising to pay checks. Banks should also be careful not to encourage use of the program in advertising, and closely monitor for misuse of the system.
“All bankers want a fair return. But bankers also have a responsibility to treat customers fairly and provide them with clear, conspicuous disclosures,” he wrote.
