Bounce Protection: How Banks Turn Rubber into Gold by Enticing
Consumers to Write Bad Checks
An Examination of Bounce Protection Plans
Consumer Federation of America
National Consumer Law Center
Banks are aggressively marketing a new form of high cost credit intended to
boost their fee income at the expense of the most vulnerable consumers. These
products are based on overdraft protection, but are not traditional overdraft
lines of credit or the occasional ad hoc practice where a bank will cover a
consumer’s bounced check as a courtesy. Instead, they are deliberate,
systemic attempts to hook consumers onto overdrafts as a form of high cost credit.
To distinguish these products from traditional overdraft lines of credit and
from the occasional, ad hoc coverage of an overdraft, we will refer to these
plans as “bounce protection.” 1
1. Description of Bounce Protection Plans
Bounce protection works like this: Participating banks advertise to consumers
that they will cover overdrafts up to a set limit for accounts in good standing
and will charge the bank’s standard non sufficient funds (NSF) fee for
each overdraft. While plans vary by bank and by the consultant’s program
employed by each bank, some common features are characteristic of these plans
are:
Consumers do not affirmatively agree to coverage; instead the bank imposes
coverage to a subset of account holders as a “courtesy” or additional
service feature of their account. Consumers who do not want this “courtesy”
must explicitly opt out by contacting the bank.2
A much larger proportion of bank customers are covered, compared to traditional
overdraft lines of credit, because customers do not sign up for the plan.3
All participating banks impose a per item fee, generally the bank’s
standard NSF or overdraft fee which is usually a flat $20 to $35. Some banks
also charge a per day fee, such as $2 or $5 per day, until the consumer has
a positive balance in her account.
Banks deduct the amount covered by the plan plus the fee by setting off
the consumer’s next deposit. This is true even when the deposit is protected
income, such as a welfare or social security check.
Bank customers are not given Truth in Lending disclosures regarding the
cost of bounce protection, which can be astronomical.
Bounce protection coverage can be accessed through payment methods other
than checks to third parties, including:4
- ATMs
- Debit Cards
- Checks and other debits cashed at the teller windows
- Online banking or voice banking line
- ACH debit transactions
Consumers are informed they have bounce protection “limits,”
which are shown as “available” amounts when consumers access information
about account balances. At ATMs, the account balance includes the amount of
the bounce protection (but the ATM does not disclose the fee for accessing
cash from bounce protection.) Some banks include the bounce protection limit
in the available balance quoted in online banking and telephone banking.5
However, some banks do not enforce these limits and allow consumers to exceed
them.
Overdrafts must be repaid or accounts brought to a positive balance within
a set period of time, generally anywhere from a few days to 30 days.
Each bank’s program sets its criteria for participation, generally requiring
that the account be open for a certain time, that there are regular deposits
to the account, and the lack of defaults or levies. The interpretation of “regular
deposits” can vary – the Indiana Department of Financial Institutions
noted that one bank only required a deposit of $500 or more in the account each
month, while another bank defined it as simply bringing the account to a positive
balance at least once every month.6
If calculated as finance charges, the Annual Percentage Rates for bounce protection
fees are astronomical. For example, a $100 overdraft will incur at least a $20
fee. If the consumer pays the overdraft back in 30 days, the APR is 243%. If
the consumer pays the overdraft bank in 14 days, which is probably more typical
for a wage earner, the APR is 541%. These APRs are probably the bottom end of
the scale.7 However, banks are able to conceal these
APRs by using a supposed loophole in Truth in Lending law.
2. Who Sells and Promotes Bounce Protection Plans
Banks themselves generally do not develop bounce protection plans on their own.
A handful of bank consultants are responsible for the creation of bounce protection
plans, marketing them to thousands of banks. A list of these consultants is
included at the end of this report.
These consultants typically offer an entire programmatic package, including
the software, customer marketing materials, and consultant support to implement
the programs at banks. In some cases, these consultants deliberately package
bounce protection plans with “Free Checking” programs.8
Federal regulation permits a bank to call a checking account “free”
as long as there is no regular maintenance fee even though the account may be
structured with the purpose of charging high fees.9
Over 1000 banks, mostly smaller community banks, have implemented bounce protection
plans. Of the large national banks, Washington Mutual Bank appears to be the
largest provider of bounce protection.10 Other large banks offering bounce protection
include TCF of Minneapolis and Fifth Third of Cincinnati.11
To get a sense of whether banks subject to all of the federal regulatory agencies
were adopting “bounce protection,” we conducted an Internet search
using the Google search engine on the phrases “overdraft privilege”
and “bounce protection.” This search turned up 32 FDIC regulated
banks, five Federal Reserve regulated banks, 15 national banks, 3 thrifts, and
a Texas credit union. This was not an exhaustive search, but demonstrates that
all types of bank charters are adopting these programs
3. Bounce Protection Advertisements Entice Consumers with the Availability
of Credit
Banks and their consultants have aggressively marketed bounce protections plans
to consumers as a form of credit that the consumers can draw upon. The following
are some sample advertisements for bounce protection:
First Federal Bank’s “Powerdraft” brochure states:
“Have you ever made a mistake in your checkbook? Have you ever been
shopping on the weekend and find a must-have item, but don’t have the
money in your checking account to cover your check? Have you ever had unplanned
expenses between paydays? There is no need to worry! With First Federal’s
Powerdraft Plan, you will be covered without the embarrassment of a returned
check.”12
Although The Cecilian Bank claims that its “Hometown Coverage”
is not a loan, it describes these benefits: “Hometown Coverage will
save you merchant and retailer fees and embarrassment when you simply make
a mistake in your checkbook, have unexpected emergencies, or run short
of cash between paydays up to a maximum of $500. Instead of returning
checks unpaid, The Cecilian Bank may automatically pay them for you with the
use of Hometown Coverage.”13
“Access your Paycheck Before you have it! Sound too good to be true?
Well it isn’t, you can now start writing checks before you get paid
without the worry of returned checks.” This is on the web site for First
National Bank & Trust Company, Oklahoma, advertising their bounce protection
service.14
Sample advertisement from Pinnacle Financial Strategies, a bank consultant
marketing bounce protection: “Take the Headache Out of Checking Account
Overdrafts. Bouncing a check can be just down right humiliating! Not to mention
those dog gone fees from the merchant. We’ve taken the headache out
of overdrafts and the bite out of some of those excess charges you face on
the merchant side. Our overdraft privilege gives you peace of mind you deserve
and a lot less headache.”15
The advertisements also consistently contradict the industry’s assertions
that bounce protection is “discretionary,” which they do to avoid
Truth-in-Lending coverage. Ad after ad for bounce protection emphasize the reliability
and “peace of mind” provided by this product. For example:
Benton Banking Company states “The newest addition to our line of
services is Free Checking and Overdraft Privilege. Overdraft Privilege gives
you the peace of mind that your checks will be honored, up to an overdraft
of $500 ($300 for Free Checking)!”16
Washington Mutual states: “Overdraft Protection: Did that last check
catch you off-guard? Don’t worry, we’ve got you covered.”17
First Community Bank of Washington: “you will know that your checks,
ATM withdrawals, Visa Check Card Purchases, and other transactions will be
honored up to your Bounce® Protection Limit.” and “Remember,
checks drawn up to the limit will not be returned, saving you the embarrassment
and expense associated with the returned check fee. This privilege can save
you money”18
A bank trade group representative has touted bounce protection by stating
“You can view it as an insurance policy.”19
These assurances of credit availability extend to non-check methods of accessing
a bank account. For example, a sample “Dear Customer” letter from
Pinnacle states: “Your Bounce Protection limit will be available to you
at the ATM. If you make an inquiry at the ATM, your balance (including Bounce
Protection Limit) will be given.”20
4. Overdrafts Prior to Bounce Protection
Prior to bounce protection, banks have traditionally charged NSF fees as a penalty,
to discourage account holders from writing checks without funds on deposit to
cover them. Banks charge a non-sufficient-funds (NSF) fee and return the consumer’s
check unpaid to the merchant. The consumer might be charged a second fee by
the merchant.
In some cases, banks will cover an overdraft at their discretion for their
preferred customers, for which they charge an overdraft fee. Bank managers usually
make the decision on which customers’ checks will bounce and incur the
NSF fee and which checks will be covered and charged the overdraft fee. Bank
officials have the discretion to forgive overdraft fees for individual consumers.
Both NSF and overdraft fees are hefty, and have been rising for the past several
years. In 2001, the average NSF fee was $20.75, up from $17 in 1997, and the
average overdraft fee was $20.50, up from $16.50 in 1997. 21
NSF and overdraft fees have increased at a rate substantially greater than the
increase in the Consumer Price Index for the same period.22
Banks will earn $30 billion in ATM, bounced check, and overdraft fees this year,
up 14% from 2001.23
These fees far exceed the cost to the bank for bouncing a check. In 1998, a
CFA report noted that it only costs banks up to $1.50 to bounce a check.24
The report quoted industry data that estimates banks incur average transaction
costs of $.50 to $1.50 to process bounced checks. Based on NSF fees charged
in 1997, bounced check fees ranged from 11 to 32 times the cost of handling
NSF checks.25
Banks justify NSF and overdraft fees that run much more than it costs the
bank to handle the checks as providing a deterrent to mismanagement of the account.
NSF and overdraft fees are considered punishment for doing something that may
be considered a criminal violation (deliberately writing checks without funds
on deposit to cover them). 26
CFA’s report estimated that banks generated more than $5.6 billion in
annual revenue and $5.2 billion in annual profits from bounced checks. 27
The report also noted that some banks use a variety of devices to increase income
from NSF checks, including changing the order in which checks clear the bank.
By programming bank computers to clear the largest checks first, a bank is able
to bounce a larger number of smaller checks than it would if the smallest checks
were cleared first.28
5. Comparison with Overdraft Lines of Credit and Other Contractual Plans
In contrast to bounce protection, banks offer a much more reasonable credit
product to the customers to avoid bounced checks – overdraft lines of
credit. Banks also offer programs where overdrafts are covered by the consumer’s
credit card or by transfers from a savings account. These products offer a better
value to consumers, as well as including Annual Percentage Rate disclosures
for the credit products so that consumers can shop around and know what they
are getting.
Interest rates for overdraft lines of credit are generally around 18% APR. 29
Over 80% of banks offer these lines of credit. Less than half of these banks
also charge an annual fee of about $15 to $20.30
A customer who applies for overdraft line of credit must meet credit-worthiness
criteria. Relatively few account holders apply for and qualify for contractual
overdraft protection.31 One of the banking consultants
who offers bounce protection explicitly stated why banks do not promote these
lines of credit and prefer bounce protection: traditional overdraft programs
are not as profitable (because they do not charge astronomical fees), and that
customers who bounce checks are reluctant to apply for overdraft protection
and may not qualify.32
6. Bounce Protection Plans Are Designed To Boost Bank Income By Encouraging
Consumers to Overdraw Their Accounts
The consultants who promote bounce protection repeatedly emphasize increase
in fee income as the major selling point. For example, Pinnacle’s website
promises banks that will raise overdraft fee income by “100%, 200%, 300%
or more!”33 John M. Floyd Associates claims
that participating financial institutions will increase its NSF income anywhere
from 50 to 300 percent.34 Furthermore, these promises
appear to bear out. First Commerce Bank in Corpus Christi, Texas, doubled its
income from insufficient funds within a year of adopting a bounce protection
plan.35
The underlying reason why fee income increases can be nothing other than an
increase in the number of overdrawn checks. The bounce protection industry must
know they are encouraging consumers to write bad checks. They are deliberately
encouraging consumers to commit an irresponsible and sometimes arguably criminal
act. Consultants urge bankers to stop thinking of “overdraft” as
a naughty word and start thinking that overdrafts are a good thing.36
Banking consultant BSG provides additional advice to bankers on how to encourage
consumers to overdraft. BSG recommends increasing overdraft income by using
reverse order check clearing, encouraging overdrafters to overdraft more frequently
and attracting chronic overdrafters. In one of its presentations posted to its
website, BSG describes how banks are doubling NSF income by currying relationships
with overdraft customers, including sending a “thank you” letter
rather than a dunning letter for overdrafts; making NSF “OK” by
allowing debit card and ATM overdrafts; and being friendly to overdraft customers.”37
John M. Floyd Associates points out that a bank account customer who writes
an average of only one NSF check per month has the equivalent earnings value
of an account holder who maintains a $12,000 average balance. Floyd advises
that, since there are so many more consumers who are likely to take advantage
of bounce protection programs than there are “affluent” account
holders, banks should take care of and value these customers.38
Furthermore, taking care of chronic overdrafters appears to mean feeding their
overdraft habit even when the bank knows the consumer is repeatedly overdrawing
his account, may be getting into trouble, or even abusing overdrafts. Consider
this example from a consumer who conducted an experiment with his checking account:
AB is a customer of a major bank, where his account includes bounce protection
of $500. AB withdraws $100 from his bank account, but only has $80 in the
account. His ATM receipt shows a balance of minus $20 after the transaction.
A few days later, AB receives a letter from his bank that he is overdrawn
by $40, including a $20 bounce protection fee.
AB does not pay the $40, but continues to withdraw cash until he reaches
his $500 limit. He does not pay the overdrawn amount and receives more letters
from his bank, which get sterner. His bounce protection is terminated. A few
days later, AB pays the overdrawn amount (including fees). Next month, AB
receives his bank statement, which shows that now only has his bounce protection
been restored, but his limit has been increased to $1,000.
7. Impact on Consumers
It appears that bounce protection programs do not set controls on how often
a consumer can overdraw the account, do not set cooling off periods between
overdrafts, do not set a limit on the number of overdrafts used in a month as
long as the “bounce protection” limit is not exceeded, and do not
verify that an account is still in good standing before approving overdrafts
after the account is originally admitted to the program. In other words, there
are no protections in place to prevent consumers from becoming mired in perpetual
debt or cascading bounce protection fees. We know of no systematic bank programs
to identify chronic users of bounce protection plans, attempt to provide counseling,
or provide information about more affordable credit products. The Office of
the Comptroller of the Currency expressed concerns about the lack of safeguards
in one overdraft plan the OCC reviewed.39
This concern is not a theoretical one – repeated overdrafts under bounce
protection can place a consumer into difficult financial circumstances. For
example, consider the consumers who overdrew their accounts and were hit with
bounce protection fees in the a recent Ninth Circuit case:40
BB is a physically disabled woman with severe depression after the death
of her husband of 35 years. Her sole income was $898 per month in Social Security
widow and disability benefits, which were direct deposited to her bank account
at Washington Mutual. BB’s bank account had a bounce protection limit
of $1,000. While BB was in the hospital for hip replacement surgery after
a fall, her daughter wrote forged checks on BB’s account and made unauthorized
charges on BB’s debit card. Washington Mutual took one and a half months
worth of BB’s Social Security benefits to pay for the overdrafts, including
$450 in overdraft fees. As a result, BB was left with no money to pay her
rent or food. She was evicted from her apartment and forced to rely on a neighbor
for food.
LL is a mentally disabled man with bi-polar disorder who lives on Social
Security Disability benefits of $752 per month. His benefits were direct deposited
into his Washington Mutual account, with a bounce protection limit of $900.
One of the symptoms of his manic phase was compulsive spending. He overdrew
his account twenty times in a one week period, and was assessed an $18 bounce
protection fee each time. When LL used his debit card to make a $3.23 purchase,
he was assessed an $18 fee. LL overdrew his account by over $1,600 (despite
a bounce protection limit of $900). Washington Mutual did not attempt to stop
LL or inquire into this erratic account activity – the activity stopped
when LL was admitted into a psychiatric facility. Instead, WAMU simply took
LL’s Social Security Disability benefits for the next month, which left
LL penniless when he was discharged from the psychiatric facility.41
Another example comes from the facts in a West Virginia lawsuit against City
National Bank:42
SJ is 71 year old woman who lives alone and whose sole source of income is
Social Security benefits of $565 a month. She has a checking account
with City National Bank. Her account has a bounce protection plan with something
called a sustained overdraft fee, in which the bank imposes a $5 per calendar
day fee for every day an account is in overdraft. SJ forgot to record
a check in her check register. The next check she wrote was for $124,
but she had a balance of only $88.21. For an overdraft of $35.79, the bank
charged a $30 NSF fee and, the next day, started charging her $5 a day for
each day the account remained in negative balance. SJ did not find out
about the overdraft until 11 days later when a letter arrived from the bank.
SJ immediately deposited enough cash to cover the overdraft and fees. For
a $35.79 loan of less than 2 weeks, the bank assessed bounce protection charges
for $75, which was one-eight of SJ’s monthly income. SJ does not
even recall receiving the notice that the bank allegedly sent stating it would
begin imposing a $5 per day overdraft fee.
Bank executives freely admit that their targets for bounce protection fees
are low- to moderate- income consumers who live on a fixed income. One bank
consultant conceded that these consumers are more likely to use bounce protection,
stating:
areas of high unemployment, higher unemployment, you typically have more
activity…If you happen to be a bank that’s on a military post,
you’re probably doing twice as much activity as any other bank. 43
Another banker has said that “It’s for the person who accidentally
overdraws the account – the blue collar, workaday folk that live from
paycheck to paycheck and cannot afford the hassle of bouncing a check.”44
These are also the same people, of course, who cannot afford to be paying excessive
loan fees on a regular basis. Banks deliberately target low- and moderate-income
consumers by placing offices in supermarkets with a middle to down market clientele.45
Furthermore, it is often a small group of vulnerable consumers that make up
most of the bank’s newly increased profits from bounce protection. One
bank consultant revealed that 80% of a bank’s overdraft income comes from
about the same 15 to 25% of their customer base.46
Another consultant estimated 4% of customers pay half the fees, as much as $2,000
per customer annually.47 This group of probably disproportionately
low- to moderate- income consumers is carrying the weight of the huge run-up
in overdraft income for banks.48
8. The Banks’ Competition for Payday Loan Business
Payday loan companies make very short term loans to bank account holders who
don’t have sufficient funds in their bank accounts. Payday loans cost
on average 470% APR and involve loans based on personal checks held for future
deposit. There has been severe criticism of payday loans by consumer groups.49
The payday loan industry exploded onto the market in the mid-90s, at about the
same time bank consultants started marketing bounce protection plans.
Banking consultants have been very specific that bounce protection
programs are the banking industry’s answer to payday loans. Several
consultants explicitly pitch their products as a competitive alternative to
payday loans.
Consultant Banking Exchange Technologies states: “Currently one of
the fastest growing segments in the financial services industry is the short
term loan, or check cashing outlets. This [bounce protection] system negates
bank customers from seeking these services outside of their bank.”50
Consultant BSG states: “Some bank customers are driven by convenience
and the need for short term funds. They are willing to pay for the privilege
of spending money they don’t quite have yet. Somehow, these customers
will get the money they need. Wary of the uncertain consequences of overdrawing
their checking account, many pay routine bills late and incur late fees, many
also choose to patronize payday loan outfits, cash checking services and the
like. The result? Your customers are paying big fees to meet their simple
banking needs, but not to you. With the OverdraftHonor program, you can give
your customers an alternative, one that saves them money while dramatically
increasing your fee income.”51
A representative of consultant BSG defended its bounce protection plan in
the pages of the American Banker in the "the best way for banks to assure
customers do not use unsavory services (such as payday-loan companies) is
to offer customers a more attractive alternative.”52
In an “industry brief” issued in 2000, Raymond James & Associates
described the operations of payday lenders in comparison to banks that charge
high NSF fees and bounce checks for customers who overdraw accounts. The brief
concludes that “if the bank priced appropriately and developed new short-term
lending products, it could provide the funds needed to drive the mortgage
companies, rental agents, utilities and others out of the market. The banks
could capture their profits.”53
Yet in some ways bounce protection is even worse than the scourge of payday
loans. The APRs for bounce protection can be several times that of payday loans,
which are already grossly usurious. Furthermore, at least payday lenders are
required to provide TIL disclosures.
Consumers are likely to incur higher dollar amounts with bounce protection fees
than payday loans, shocking as that may be. A typical payday loan consumer may
pay $50 for a $400 loan of 2 weeks, which is already an excessive fee. A consumer
who borrows that much from a bounce protection plan faces a real possibility
of paying more, because the consumer will have accessed the credit using multiple
payment methods and incurring multiple fees. For example, the consumer might
have overdrawn $400 by writing 3 checks for $100, withdrawing $100 from an ATM,
and using her debit card to pay $100. Since she has made 5 transactions that
overdrew her account, she will be charged 5 times for probably at least $20
– making that $100 in fees or twice the payday loan fee.
Reforms
With bounce protection, the banking industry has entered into the fringe lending
market, promoting an extremely high-cost credit product to low- and moderate-income
consumers. Banks should not be permitted to this. The following reforms, which
have been recommended to the Federal Reserve Board, would prevent the abuses
of bounce protection plans.
Banks should be prohibited from imposing bounce protection plans on consumers
without their affirmative consent.
Truth in Lending disclosures should be required for bounce protection, including
per item and per days fees. Disclosures should be made at ATMs when consumers
withdraw cash.
Banks should be prohibited from stating that bounce protection is “discretionary”
when they have advertised, represented or implied that consumers should have
the expectation bounce protection will cover overdrafts.
Banks should be prohibited from advertising or promoting any plan that
encourages consumers to write NSF checks or take other steps that might have
criminal consequences.
Banks should be prohibited from promoting bounce protection plans without
informing consumers of other less expensive alternatives.
Banks should be prohibited from seizing customers’ exempt funds (e.g.
SSI benefits deposited directly into the account by the Social Security Administration)
to repay the debt.
Attachment 1
Consultants That Market Bounce Protection Plans
The following is specific information regarding each of the eight bank consultants
that market bounce protection to banks.
Strunk & Associates, L. P., located in Houston, TX and
Parkville, MO, describes itself as “a financial institution advisory service.”
Strunk is reported to have 540 banks who use its bounce protection plan as of
November 2002, according to a Newsweek column. Strunk has an alliance with a
subsidiary of America’s Community Bankers, the thrift trade group, to
provide its Overdraft Privilege Program to ACB members.54
John M. Floyd, is based in Houston, TX, sells a plan called
“Overdraft Privilege.” The company states that it provides bounce
protection services to 1400 financial institutions. John M. Floyd also emphasizes
that its program is coupled with Free Checking Programs.55
BSG, LLC, formerly Bank Strategy Group, is based in Louisville,
KY. It markets “OverdraftHonor” product to banks. BSG tells bankers
that many banks using OverdraftHonor have achieved growth of 70 to 100 percent
in overdraft fee income and sets it fee based on the incremental pre-tax profit
it generates for banks.56
Pinnacle Financial Strategies from Houston, TX, markets its
program as trade-marked brands “Bounce Protection,” “No Bounce
Advantage,” and “No Return Benefit.” Pinnacle claims more
than 200 banks have implemented its overdraft protection program.57
Moebs Services markets a “No-Bounce” program.
Moebs claims the highest overdraft limits, bulletproof compliance, highly controlled
and very low check losses, and a No-Bounce and free checking program that can
be used together or separately.58
Alex Sheshunoff Management Services, L.P., based in Austin,
TX, markets “Platinum Overdraft.” The Sheshunoff software includes
these features: Detailed customer screen, record and history for contact management;
complete history on all overdrawn customers for analysis and data mining; automatic
tracking of new start loans, recoveries, and charge-offs; automatic electronic
reporting to Chex Systems; tracking of every letter, phone call or activity
with a customer, and scripts for easy training. 59
IFS Impact Financial Services, based in Little Rock, Arkansas,
markets Free Checking with Overdraft Privilege to banks. Its only business is
NSF Fee Income Enhancement, and includes Automated Overdraft Privilege, Free
Checking, and “Fresh Start” Collection Plan.60
Haberfield Associates, from Lincoln, Nebraska, has more than 300 client
banks in 49 states who offer free checking with overdraft “privileges.”61
This letter responds to your correspondence with Brenda Curry, District Counsel
of our Southeastern District Office, which was referred to our Washington Headquarters
office. You had formally requested a program evaluation/comfort letter in connection
with [an overdraft protection program] (Program) offered
by [ 3rd Party ].
We have reviewed the materials that were submitted along with your letter,
and we are unable to provide such a letter. In our view, the Program presents
a number of concerns, which we summarize below.
Compliance Issues
Truth in Lending/Regulation Z
An overdraft would be “credit,” as defined by the Truth in Lending
Act and Regulation Z. 15 U.S.C. § 1602(e). The key issue under Regulation
Z, however, is whether the fee charged in connection with the overdraft is a
“finance charge.” The answer would depend on:
Whether a nonsufficient funds (NSF) fee charged by the bank is the same
whether the NSF check is paid or returned; and
Whether there is an agreement between the bank and the accountholder pursuant
to which the bank will pay the accountholder’s NSF checks and impose
a fee for doing so.
See 12 C.F.R. §§ 226.4(b)(2) and (c)(3).
If the fee were determined to be a finance charge, the bank would have to make
the disclosures required in Regulation Z for open-end credit. See, e.g., 12
C.F.R. §§ 226.5 and 226.6.
Truth in Savings/Regulation DD
Certain fees must be disclosed in connection with a deposit account. At the
time an account is opened, the disclosures must include the amount of any fee
that may be imposed in connection with the account (or an explanation of how
the fee will be determined) and the conditions under which the fee may be imposed.
12 C.F.R. § 230.4(b)(4).
If the Program were added to an already existing deposit account, advance notice
to the accountholder may be required. A bank must give advance notice (at least
30 days before the change) to affected customers of any change in a term that
was required to be disclosed under § 230.4(b) (which includes fees
imposed in connection with the account) if the change may reduce the annual
percentage yield or adversely affect the consumer. 12 C.F.R. § 230.5(a)(1).
Electronic Fund Transfer Act/Regulation E
In connection with the [................ ] Repayment
Agreement, the customer is urged to repay the amount of the unpaid overdraft
over time through preauthorized transfers from his/her checking account. A participating
bank would need to comply with the Regulation E requirements for preauthorized
transfers. 12 C.F.R. § 205.10(b).
Equal Credit Opportunity Act/Regulation B
An “overdraft” would be “credit” under Regulation B.
See 12 C.F.R. § 202.2(e). A memorandum from [ ........A.......
] of [ ............3rd Party...........
] to [..... B....
], dated June 10, 2000, provided criteria for selecting “ineligible
(excluded) accounts,” i.e., those accounts that are not eligible for the
Program. Among those accounts are: “Accounts which, in reviewing officer’s
judgment, should not receive the automated overdraft payment service, such as
(See sample memo): Not creditworthy or questionable financial condition.”
(Emphasis in original.)62
The materials do not appear to provide any indication of standards for the
reviewing officer’s determination. When a decision is left to bank personnel’s
discretion, there may be a potential for disparate treatment in violation of
ECOA and Regulation B. See 12 C.F.R. § 202.4.
Federal Trade Commission Act
The Federal Trade Commission Act prohibits deceptive acts or practices, including
representations or omissions that are likely to mislead reasonable consumers
and, thus, affect a consumer’s choice or conduct regarding a product.
See 15 U.S.C. § 45(a)(1) and the FTC Policy Statement on Deception
(October 14, 1983).
The marketing materials for the Program send a mixed message as to whether
the bank is committing to pay overdrafts as long as the account meets the stated
qualifications for the Program and also raise numerous ambiguities about or
overstate the benefits of the Program:
In a number of places the materials make such statements as “we will
pay your checks ... if you maintain your account in good standing.”
The back of the marketing materials, however, states that “we may refuse
to pay an overdraft for you” and that this is being done as a “non-contractual
courtesy.” 63
The materials give the wrong impression about the scope of the protection
offered by the program and oversell its benefits. Claims of “no more
charges from retailers for insufficient checks,” “make a mistake
-- you’re covered,” and “write a check or use an ATM for
more than you have in the bank -- you’re covered” are broad statements
given the limitations placed on the program.
The materials may leave the customer with the wrong impression about what
the actual overdraft limits are. For instance, with respect to an account
to which a $500 limit is applicable, the bank would not, under the program,
pay an overdraft that exceeded $480 because the $20 NSF fee, would cause the
overdraft to exceed the $500 limit.64
The requirement that the account need only be brought to a positive balance
once every 30 days also may be illusory. We note that the materials provide
that “The amount of any overdrafts plus our Non-Sufficient Funds and/or
Overdraft (NSF/OD) Charge(s) that you owe us shall be due and payable upon
demand.”65
Regulation O
Overdrafts are considered extensions of credit for purposes of Regulation O.
12 C.F.R. § 215.3(a)(2). If, as some of the materials appear to indicate,
a bank also makes this product available to certain bank insiders, issues would
appear to arise under Regulation O governing extensions of credit to bank insiders.
Supervisory Concerns
Your characterization of the product as something other than lending raises
supervisory issues:
It is possible that overdrafts would be paid for customers who would not
qualify for loans under the prudent underwriting standards that the bank should
use for all of its extensions of credit. This could increase a bank’s
credit risk profile (e.g., higher delinquency and loss rates) by extending
credit to borrowers that may not have normally qualified for payment of overdrafts
or overdraft protection;
Given the loss history of bank overdraft programs, bank management must
develop reasonable loss recognition guidelines and establish loan loss reserve
methodologies to ensure timely loss recognition and estimated loss coverage.
Although the submitted material indicates a measuring and monitoring process
(infers MIS reporting), it is unclear what this entails, including the types
and quality of information provided to a bank to assess credit risk performance
on a periodic basis. Banks must have appropriate MIS reporting established.
Banks also need to take great care in entering into contracts with third
party vendors.66 This raises a variety of supervisory
concerns that banks should address before entering into an arrangement with
a vendor in connection with the potential purchase of products including:
Most banks have software already capable of overdraft protection without
incurring the high up-front and ongoing costs of the Program. Consequently,
the benefits of the Program are not readily evident, in that a bank could
otherwise achieve the same results if it implemented and marketed its existing
capabilities;
It appears that the arrangement a bank enters with the vendor to participate
in the Program is devised in such a manner that only the bank is subject to
the credit and reputation risk, while the vendor shares the benefits, i.e.,
the income;
Banks are expected to conduct due diligence reviews of vendors. This includes
initial and ongoing reviews of the financial information of any vendor. These
reviews are necessary to ensure that the company can fulfill the representations
as outlined in the contract. Requirements for the timing and quality of financial
information should be set forth in the contract;
The sample contract indicates a termination clause that appears to prohibit
or severely restrict the contracting bank’s ability to terminate once
the program is initiated. Only the vendor has control of termination, and
the only termination consideration is if the 150% fee income profitability
goal is not achieved. This one-sided termination clause is potentially detrimental
for the bank from a reputation, financial, and strategic risk perspective.
Under the contract, the bank has no recourse if it becomes dissatisfied for
a variety of reasons such as customer satisfaction/bank reputation and credit
risk issues (e.g., 50% of the customers complain or 15% delinquency rate).
Policy Issues
The Program is designed to increase fee income by encouraging customers to
write NSF checks. Although the Program may be valuable to customers who might
inadvertently or infrequently write an NSF check, banks participating in the
Program will, in essence, attempt to entice their customers to write NSF checks
more frequently and on purpose in order to generate fee income. This use of
the Program could promote poor fiscal responsibility on the part of some consumers.67
In this regard, we note the complete lack of consumer safeguards built into
the program:
in some circumstances the charges assessed on customers may be just as burdensome
as those imposed on borrowers utilizing other types of high interest rate
credit;68
an unlimited number of overdraft charges could be levied during a 30-day
period as long as the consumer does not exceed the dollar amount limitation
on overdrafts;
no cooling off period following the repayment of overdraft amounts during
which no overdrafts would be paid, thus increasing the likelihood that a customer
would consciously resort to use of this product to pay for ordinary day-to-day
expenses;
no grace period (for instance, 24 hours) during which the customer can reimburse
the bank without incurring the NSF charge after receiving notice that a check
was paid;
no effort by banks offering this program to identify customers who are writing
overdraft checks regularly as a means of meeting regular obligations in order
to attempt to serve their needs through more economical alternatives; and
no effort by banks offering the program to inform customers generally of
available alternatives for short-term consumer borrowing, explain to customers
the costs and advantages of various alternatives to the program, or identify
for customers the risks and problems in relying on this product and the consequences
of abuse.
Thank you for the opportunity to evaluate the Program. We hope that this information
is useful to you.
Sincerely,
-signed-
Daniel P. Stipano
Deputy Chief Counsel
____________________________
1 This is the terminology used by the Federal Reserve Board
in its recent request for comments on this issue. 67 Federal Register 72618,
December 6, 2002.
2 Gloria Irwin, “Overdraft Protection: Courtesy or Curse?”
Beacon Journal, October 20, 2002.
3 One bank consultant that offers these plans, Strunk and Associates,
tells bankers that its program is designed and managed to allow the bank to
offer its bounce protection plan to 90 to 95% of their consumer checking customers.
Strunk and Associates, L.P. Overdraft Privilege Program marketing materials,
on file with authors.
4 Alex Berenson, Some Banks Encourage Overdrafts, Reaping Profit,
New York Times, January 22, 2003, at A1.
6 Indiana Department of Financial Institutions, Newsletter
– Winter 2002 Edition (November 2002), at 2.
7 An example of an overdraft with an APR of 1520% is described
in Iowa Consumer Credit Code Administrator, Informal Advisory # 88, “Per
Diem Charge on Honored NSF Checks As A Finance Charge Under the ICCC and Iowa
Common Law,” issued August 12, 1999, on file with the authors.
8 According to consultant Struck & Associates, L.P., banks
that use its programs in conjunction with fee-checking accounts average $150
in overdraft fees a year. Allan Sloan, “No Such Thing As a Free Check,”
Newsweek, November 18, 2002.
9 Regulation DD, 12 C.F.R. § 230.8 (a).
10 Washington Mutual earned $1 billion from overdraft fees
last year. Alex Berenson, Some Banks Encourage Overdrafts, Reaping Profit, New
York Times, January 22, 2003, at A1.
11 Allan Sloan, “No Such Thing As a Free Check,”
Newsweek, November 18, 2002.
12 First Federal’s Convenient Overdraft Coverage Plan
brochure, on file with authors.
13 Hometown Coverage brochure, The Cecilian Bank, on file
with authors.
19 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1 (quoting Diane Casey, president
of American’s Community Bankers).
20http://www.pinnaclefinancialstrategies.com/products/products2.html,
visited January 22, 2003. Pinnacle Financial’s web page promotes bounce
protection to banks as well by emphasizing the product as a credit product,
stating: “Your customers get the financial safety net and extra spending
power they deserve while you meet their need for flexible financial services
and grow fee income” and that customers will “extend their cash
base, when they have made an honest error in their checkbook or need a little
extra cash before payday.” www.bounceprotection.com/products/overdraft.html
and www.bounceprotection.com/products/benefits.html,
visited January 17, 2003.
21 Board of Governors of the Federal Reserve System, “Annual
Report to the Congress on Retail Fees and Services of Depository Institutions,”
July 2001 p. 5.
22 Timothy H. Hannan, “Retail Fees of Depository Institutions,
1997-2001,” Federal Reserve Bulletin, September 2002, p. 409.
23 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1.
24 Consumer Federation of America, “Bounced Checks:
Billion Dollar Profits II,” June, 1998.
25 Id.
26 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1.
27 Id.
28 Id.
29 American Bankers Association , “Retail Banking Survey
Report,” (2001) at 82 (Table 75: OVERDRAFT PROTECTION).
30 American Bankers Association , “Retail Banking Survey
Report,” (2000) at 87 (Table 108: OVERDRAFT PROTECTION).
31 Bob Giltner, Bank Strategy Group, Letter to Editor, “Bounce
Coverage Ensures Equitable Treatment for All,” American Banker, April
20, 2001, at 16.
35 Laura K. Thompson, “Overdraft Play Looks Better to
Small Banks,” American Banker, April 2, 2001, at 1.
36 Id.
37 Bank Strategy Group, “Creating a Sales Culture in
Banking and Financial Services,” CFO’s and Controllers Conference,
Bank Administration Institute, posted at www.bankstrategy.com.
39 Daniel P. Stipano, Deputy Chief Counsel, Office of Comptroller
of Currency, Interpretive Letter #914, September 2001. A copy of this letter
is attached as Attachment 2.
40 The published opinion for this case is Lopez v. Washington
Mutual, 302 F.3d 900, amended at, 311 F.3d 928 (9th Cir.2002). These summaries
are based on court documents supplied to the authors.
41 See Memorandum of Points and Authorities in Support of
Plaintiff’s Motion for Summary Judgment, Lopez v. Washington Mutual Bank,
No. C99-20890 (N.D. Cal. December 8, 2000).
42 Facts as related by SJ’s attorney, Mountain State
Justice in West Virginia, correspondence on file with authors.
43 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1 (quoting Dick Gowdy, executive
vice president of Strunk & Associates).
44 Laura K. Thompson, “Overdraft Play Looks Better to
Small Banks,” American Banker, April 2, 2001, at 6.
45 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1.
46 Laura K. Thompson, “Overdraft Play Looks Better to
Small Banks,” American Banker, April 2, 2001, at 6.
47 Alex Berenson, Some Banks Encourage Overdrafts, Reaping
Profit, New York Times, January 22, 2003, at A1.
48 Some of these low- and moderate-income consumers are those
who received government benefits, such as Social Security, SSI and TANF. Under
the decision in Lopez v. Washington Mutual, 302 F.3d 900, amended at, 311 F.3d
928 (9th Cir.2002), banks are free to recoup both overdrawn amounts and their
excessive fees from protected income. Thus, the most vulnerable members of our
society who are gouged by these products are also deprived of the safeguards
that apply to most other creditors. And for other creditors, they at least are
required to provide APR disclosures and to whom consumers consented to getting
credit. It is sadly ironic that the most extortionate product on the small loan
market is the one that has the most power to raid the assets of consumers who
Congress thought were entitled to special protections.
49 Jean Ann Fox, Consumer Federation of America, The Growth
of Legal Loan Sharking: A Report on the Payday Loan Industry, November 10, 1998;
Elizabeth Renuart, National Consumer Law Center, Predatory Small Loans: A Form
of Loansharking.
52 Giltner, Bank Strategy Group, Letter to Editor “Bounce
Coverage Ensures Equitable Treatment for All,” American Banker, April
20, 2001, at 16.
53 Raymond James & Associates, “Pay Day Loan Companies
Take Bank Customers – and Profit?? – At Will,” Industry Brief:
Financial Services, February 7, 2000, at 4.
61 Allan Sloan, “No Such Think as a Free Check,”
Newsweek, November 18, 2002.
62 Elsewhere the materials provide that the management component
of the program “involves the Operations person making judgments on when
to pay over the specified limit, when to restrict or otherwise curtail the privilege,
when to charge off delinquent accounts.”
63 Other materials also introduce language that could be construed
as providing a basis for the bank to not pay overdrafts despite representations
otherwise. Marketing materials state that if an account is in good standing,
the bank will “normally” pay overdrafts up to the stated limits.
At another point in the materials, it states that if the account is in good
standing we will approve your “reasonable” overdrafts. Elsewhere,
the materials refer to the program as a “non-contractual customer courtesy
that can be withdrawn at any time.” In addition, the requirement of a
positive balance at least once every 30 days is, at some places, stated as the
“need to make regular deposits to bring the account to a positive balance
at least once every 30 days.” It is unclear if this is one test or two
– in other words, even if the account is brought to a positive balance
in 30 days, can the overdraft feature be terminated if the bank did not consider
“regular deposits” to have been made and, if so, what constitutes
the making of “regular deposits.”
64 The marketing materials address this but only in a rather
oblique way:
[ Program ] adds a pre-approved $500 overdraft
limit to your personal checking account. If you overdraw your account, Bank
will cover each check up to $500 limit. You still pay Bank’s standard
overdraft fee for each item returned, but the benefits are worth it.
This representation nowhere alerts the customer that Bank will not, under the
program, pay a check in an amount between $480 and $500 or pay, for instance,
five overdraft checks in an amount between $400 and $500. Where the disclosure
about the relationship between fees and the overdraft limit is made, it is set
forth in an unduly complicated manner: “... we will normally honor (pay)
your overdrafts up to the limits mentioned above, including our normal Non-Sufficient
Funds (NSF) Charge(s).” It is not readily apparent that this disclosure
would alert a customer that the overdraft fees are deducted from the overdraft
limit.
65 This lack of forthrightness in dealing with customers also
is demonstrated by a sample letter, advising a consumer that s/he has just a
few days to bring his/her checking account to a positive balance, which indicates
that the customer may qualify for the [ ] Repayment Plan; but a follow-up letter
sent when the customer fails to bring the account to a positive balance within
the time period advises the customer that s/he has been “pre-approved”
for the [ ] Repayment Plan. Moreover, the materials generally indicate that
a person who fails to bring the account to a positive balance in the allotted
period will be offered the opportunity to repay the overdraft in equal installments
spread over a period of from six to 12 months.
Moreover, the integrity of the various representations are also called into
question by the following typed notation on one aspect of the disclosures:
[NOTE REGARDING POSITION OF FREE CHECKING: Position the disclosure somewhere
in the middle of the checking account disclosures to avoid calling unnecessary
attention to the Free Checking account.]
66 See OCC Advisory Letter No. 2000-9, “Third-Party
Risk” (August 29, 2000).
67 The materials are contradictory with respect to a bank’s
expectations about the use that its customers will make of the program. On the
one hand, a sample letter states that the program “is not an invitation
to overdraw your account, it is an added layer of protection should you accidentally
write checks for more than you have in the bank.” On the other hand, marketing
materials state: “Once you [the bank] and [ 3rd party
] install and implement the process, a phenomenon occurs. Your customers will
use it and use it and use it ... and your NSF income will soar.” At another
point, the marketing materials advise the customer: “This [overdraft
privilege] is extended to you to provide additional flexibility
and convenience in managing your funds . . . .” It belies logic to conclude
that the customers will accidentally “use it and use it and use it”
and that the program is designed to provide accidental “additional flexibility
and convenience” to customers in managing their funds.
68 For instance, a customer with a $500 overdraft limit who
writes seven NSF checks in a month for a total overdraft of $360 would be assessed
$140. We note, too, the observation in the materials with respect to the [repayment]
program that “the customer will be encouraged to come in, acknowledge
the OD amount (a large portion of which will now be fees), and set up a payment
plan.”
and NCLC