The Outsized Implications of the End of Overdraft Fees

Mar  10 
Brian Boardman  Director, Advisory Services, Fiserv 

How looming policy modifications could affect your organization's bottom line

Financial institutions nationwide are changing many of their policies related to overdraft fees, which has important ramifications for every organization.

Modifications made by financial institutions range from increasing the amount by which an account can be overdrafted before an accountholder is charged a fee, to drastically reducing or completely eliminating nonsufficient funds and overdraft fees, all in an effort to simplify and improve customer relationships.

Bank of America, JP Morgan Chase, Wells Fargo, PNC Bank and Capital One have made recent changes to their overdraft policies, and this trend will not be limited to large banks. Community banks and credit unions are taking notice and beginning to review their overdraft policies and practices. Many industry experts expect that very soon, most financial institutions will have significantly less income associated with overdrafts and will have modified their risk tolerance for overdraft balances.

There will inevitably be other, perhaps sweeping, changes to products, policies, practices, and associated charges and fees. It's important to understand and plan for any potential impact to your organization's bottom line.

As these developments unfold, there are five likely implications of the end of overdraft fees.

Getting started now on possible changes to overdraft practices will help your financial institution stay ahead while providing a better path to profitable customer relationships. 

1. The Rise of Incentive-Based Free Checking

If customers want no-fee checking, they'll likely be asked to expand their relationships with their financial institutions. The deeper their relationships, the greater the chance they will qualify for free checking.

For years, a justification for free checking was overdraft income, which one consultant's model touted as their entire business case for the service. But in this changing environment, it will be difficult for financial institutions to continue to offer no-fee checking and maintain an acceptable level of profitability.

Instead, financial institutions are introducing monthly service charges while adding qualifiers and incentives as a path to free checking. Rewarding certain actions, such as debit card transactions, direct deposits, additional accounts, maintenance of higher balances and use of digital banking tools, deepens relationships with retail and business customers and encourages account retention.

2. Implementation of System Checks and Process Validations

The end of overdraft fees may mean the beginning of more buttoned-up pricing policies and practices. Ensuring fees and charges are well-defined and clearly disclosed to accountholders is the first step, followed by the consistent implementation of pricing policies.

Too often, system specifications for billing are set up incorrectly, operational processes are not followed, or policies incent behaviors that result in fee avoidance. Financial institution should evaluate the automation of any manual processes for determining  if and how much a customer should be charged, and set clear guidelines on how to navigate waiver and refund policies. Assessing and validating specifications, policies and processes may lead to improved bottom-line results.

3. Modification of Risk Management

Even with changes to overdraft policies, some accountholders will continue to withdraw or charge more money than they have in their accounts. However, the reduction or elimination of fees associated with these updated policies mean the compensation organizations receive for taking on risk for their deposit customers will be significantly reduced. Processes and technology will need to change to reflect this changing environment, including a focus on setting appropriate overdraft limits. Assessing and managing risk at the account level will help financial institutions set dynamic overdraft limits based on customers' history, behaviors, transactional information and ability to repay. 

Changes to overdraft policies will also result in more exception items being returned by paying institutions so as not to increase their own risk. In response, many financial institutions may need to redesign their exception item operations, including staffing.

Whether any operational redesign will lead to expense reductions or expansion will depend on the level of examination each financial institution decides to take. 

Assessing and managing risk at the account level will help financial institutions set dynamic overdraft limits based on customers' history, behaviors, transactional information and ability to repay.  

4. An Increased Focus on the Customer Relationship

Given the changed risk considerations tied to modifications to overdraft policies, the customer relationship will take on heightened significance in overdraft decisions. Diligence will be required to make informed decisions on covering an overdraft or returning items. This requires good data and an understanding of the customer at the individual level. Implementing relationship-driven decision making will help organizations balance risk with the preservation of important accountholder relationships.

Surveys show that some consumers who use overdraft see it as an expensive form of credit. For these customers, small, instant loans may meet their needs while eliminating the need for the financial institution to continue to enable overdrafts on their account, helping the financial institution maintain relationships while managing expenses.

5. The Growing Importance of Recovery Services

If changes to overdraft polices lead to significantly more items being returned, businesses will need a way to recover their risk and collection costs. This can be good opportunity for financial institutions to implement or expand their transaction recovery services.

Using traditional collection methods, businesses typically recover only a fraction of funds from returned items. When transactions don't go through, helping businesses recover funds saves them time and resources spent on collections. For financial institutions, offering recovery services can strengthen relationships with business customers and help replace lost revenue from overdraft fees.

Responding to Major Changes

Where your institution focuses its efforts will be driven by current overdraft practices and the effect of changes to those practices on income. The larger the impact, the more extensive implementation of other changes will be for your organization. Getting started now on possible changes to overdraft practices will help your financial institution stay ahead while providing a better path to profitable customer relationships.

Of course, any changes to overdraft practices and policies will have significant consequences for your retail and business customers. Guiding them through those changes will help strengthen relationships with your accountholders while guarding profitability for your organization.