Have you received one of those letters from your bank strongly suggesting that you need to opt-in to overdraft "protection"? I put protection in quotes, because what the banks offer isn't really any protection at all. Rather, it's a license to take your hard-earned money through expensive fees, sometimes through no fault of your own.
In the aggregate, fee-based overdraft programs cost consumers at least $23.7 billion each year -- more than the loans extended in exchange for those fees, which amount to $21.3 billion. Debit card transactions, the most common triggers of overdraft fees, cause an average overdraft of under $17, yet trigger an average fee of $34. And this fee -- twice the size of the loan itself -- provides the account holder no benefit of avoiding an expensive denied transaction because the cost of a denied debit card transaction is zero.
The FDIC's recent study of overdraft programs found that account holders who overdrew their accounts five or more times per year paid 93 percent of all overdraft fees. It also found that consumers living in lower-income areas bear the brunt of these fees. Seniors, young adults, military families, and the unemployed are also hit particularly hard. Older Americans aged 55 and over pay $6.2 billion in total overdraft fees annually -- $2.5 billion for debit card/ATM transactions alone -- and those heavily dependent on Social Security pay $1.4 billion annually.
What you may not know, is that according to a Consumer Federation of America study conducted last spring, almost all of the largest banks process payments largest first, which significantly increases fees for low-balance customers. Paying largest transactions first causes substantial consumer injury, racking up multiple fees when a single large payment exhausts available funds. Consumers can't reasonably avoid this problem since account holders have no control over the order in which transactions are presented or institutions clear transactions.
And, despite the banks' claims to the contrary, the injury is not outweighed by the countervailing benefits to consumers or competition. Banks with fee-based overdraft programs pay the bulk of all transactions, so arguing that consumers benefit from high-to-low processing order is disingenuous. Banks make vague disclosures about processing order and do not compete on the basis of paying the most transactions possible from available funds. Processing transactions in order from high to low is a revenue enhancer, not a consumer service.
Beyond clearing transactions from high to low, banks can further maximize fees through the order in which they clear different transaction types (debit card, checks, etc.). A federal court recently found in Gutierrez v. Wells Fargo that the bank had changed its procedure to process all withdrawals together, rather than paying all (typically smaller) debit card transactions before all (typically larger) checks, to maximize fees.
The court in that case ordered Wells Fargo to pay over $200 million to its California customers alone in reimbursement for fees caused solely by transaction reordering. The court noted, "the only motives behind the challenged practices [high to low processing and authorizing debit card overdrafts] were gouging and profiteering" and high to low processing is:
...a trap -- a trap that would escalate a single overdraft into as many as ten through the gimmick of processing in descending order. It then exploited that trap with a vengeance, racking up hundreds of millions off the backs of the working poor, students and others without the luxury of ample account balances.
Regulators like the FDIC, the Office of Comptroller of the Currency (OCC), the Office of Thrift Supervision, and the Federal Reserve are finally starting to look at the problems of overdrafts and to take action to rein them in. The FDIC's recently proposed guidance to the banks it regulates marks a significant step forward in this area. The guidance notes that the agency expects banks to avoid maximizing overdrafts through clearing order and provides two examples of appropriate procedures: clearing items in the order received or by check order.
The Federal Reserve Board should take prompt action to stop banks from manipulating payment order to drive up overdraft fees. Come July 21, 2011, the new Consumer Financial Protection Bureau will be up and running, and will be able to rein in these unfair practices. In the meanwhile, in a recent letter, we urged the OCC to put a stop to this "gouging and profiteering" by national banks immediately by making clear that banks should not 1) process transactions in order from high to low, within a single transaction type or across all transaction types; or 2) process debit card and ATM transactions before other transactions in order to maximize overdraft fees for account holders who are not enrolled in fee-based overdraft for debit card and ATM transactions; or 3) otherwise post transactions in an order that maximizes fees.
Willie Sutton is credited with saying that he robbed banks because that's where the money is. Banks know where the money is, too: overdraft fees. Banks seem to have decided to process payments in the order that best suits them because that's where the money is -- for them. We call on bank regulators to rein in this unfair and fee-maximizing practice immediately.