The Impacts of Overdraft Programs on Consumers

The Regulatory Studies Program (RSP) of the Mercatus Center at George Mason University is dedicated to advancing knowledge of the impact of regulation on society. As part of its mission, RSP conducts careful and independent analyses employing contemporary economic scholarship to assess rulemaking proposals from the perspective of the public interest. Thus, this response to the Bureau of Consumer Financial Protection’s notice and request for information, hereafter referred to as the “notice,” does not represent the views of any particular affected party or special interest group, but is designed to assist the Bureau of Consumer Financial Protection (CFPB) as it seeks to ascertain the effects of overdraft protection on consumers.

Introduction

This public interest comment is broken into two sections. The first raises concerns about the approach that the CFPB and other federal agencies have taken with regard to overdraft protection. Specifically, we will examine the guidance issued by the Federal Deposit and Insurance Corporation (FDIC), discuss who the typical users of overdraft protection are and why they choose to use it, examine overdraft protection’s impact on competition, and look at how overdraft protection has helped spread the availability of free checking. The second part of our comment will address six of the specific questions asked by the CFPB in the notice. The Mercatus Center considers overdraft protection to be a beneficial service not just for those that directly utilize it, but for all consumers of U.S.-based banking services.

Profits gained from overdraft protection have been used by banks to expand services and accessibility for customers both rich and poor, and limiting overdraft protection may threaten many of the benefits that it makes possible.

Users of Overdraft Protection

Contrary to many accounts, users of overdraft protection are not the very poor. By definition, overdraft borrowers have a bank account, which distinguishes them from many unbanked consumers and suggests that they have higher and more stable incomes than users of alternative financial products such as payday lending and pawnshops. Moreover, access to overdraft protection is commonly linked to the direct deposit of payroll checks, suggesting that many overdraft customers are also steadily employed. Finally, overdraft protection was originally a benefit offered to high-income customers, so there is no reason to presume that it is a product exclusively or even primarily meant for low-income customers.

Thus, according to the available research, the significant distinguishing feature of heavy overdraft users appears to be their credit score, not their income or another demographic attributes. After all, overdraft fees can be entirely avoided by using responsible financial management. One regional bank found, for example, that 71 percent of its free checking accounts with average balances of less than $250 incurred no overdraft fees in the one-year period between October 2009 and October 2010 (a total of 105,000 accounts). Moreover, the percentage of low-balance accounts that incurred zero overdraft fees during that period (71 percent of all accounts) was actually higher than the overall percentage of all accounts at the bank that incurred no overdraft fees (62 percent). Those who are financially responsible can and do manage even low-balance accounts without triggering overdraft fees. Regulators have implicitly assumed that overdraft fees are a function of income, and have overlooked the important role of consumer responsibility in avoiding overdraft fees.

Research has also shown that overdraft users are fully aware of the costs and risks of using overdraft protection. In connection with the Federal Reserve’s amendments to Regulation E, Macro International Inc. conducted consumer surveys to see whether consumers understood standard disclosure forms regarding overdraft protection. They found that consumers understand the concept of overdraft protection—that the institution will cover its customers’ overdrafts for a fee, and that they will be enrolled in the service automatically unless they opt out. They also understood what would happen when they overdrew their account by using an ATM, a debit card, recurring debit, or a check transaction. Subsequent research confirmed that consumers are able to understand overdraft programs.

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