Discretionary Overdraft Services (aka ODP programs) have consistently generated strong emotions, but many consumers have made clear their wishes: they like ODP. Some banks have the non-interest income to prove it.
Discretionary overdraft authority for checking accounts has always been a part of the banking and thrift industries. Until July 1, 2000, there were regulatory limitations within the credit union industry, but the National Credit Union Administration amended its regulations on that date to allow discretionary overdraft services in substantially the same manner as banks and thrifts.
Nevertheless, ODP programs have been under close regulatory scrutiny for the last three or four years. On Feb. 18, 2005, the FFIEC released its Joint Guidance on Overdraft Protection Programs. Does this mark the end of an era, or the beginning of another one? The language within the guidance is subject to interpretation—how to construe terms like, “readily understandable,” “clearly disclose,” “clearly explain,” or “institutions should consider,” for example. But all financial institutions are in business to serve and satisfy their customers, so if ODP was a bad thing, customers would have figured it out, complained, or moved their business. I believe these recent guidelines will cause most organizations that haven’t done so already to seriously consider ODP programs.
ODP programs are extended as a non-contractual courtesy, applied to most consumer and commercial checking accounts. No paperwork on the part of the customer is required to participate in the service, and no service charges are applied to the customer’s account unless she uses the “privilege.” Should a customer write a check, make an ATM withdrawal, or make a debit card purchase for more than the funds in her account, payment of that transaction into the overdraft is considered according to the policies and procedures established by the bank. This saves the customer money (by avoiding merchant returned check charges), inconvenience, and potential embarrassment. It can also generate a substantial increase in fees for the bank.
How did all this come about? Over the last quarter century as banks have grown and transaction volumes increased, banks were forced to automate many of their processes and procedures. Along the way, bankers learned how to automate the formerly manual NSF/OD decision process very effectively.
Somewhere along the line innovative banks also discovered that there was incremental income to be made by paying most items, even without a written agreement from the customer. Since most customers are honest, the incremental income more than offset the incremental losses. That’s also about when it was discovered that, instead of complaining about the additional fees, some consumers LIKED the idea of the bank paying more of their checks into the overdraft. Perhaps it made them feel important (“I must be a big shot if they’re afraid to return my checks!”) or—more likely—it was an act of rationality, because customers didn’t also have to pay a hot check charge to the merchants where the checks were written.
The bottom line is that bankers learned that the risk associated with small dollar overdrafts (when done properly) was minimal and that the benefits to the customer and the related income were substantial. Over the last few years, ODP has become a common practice within financial institutions of all sizes, all across the nation.
Could one argue that much of the money to “fund” the additional fees banks now collect comes not from consumers but from the merchants who don’t collect as much in hot check charges? I think so!
Whether you agree with that assertion or not, non-interest income is an increasingly significant source of revenue for most financial institutions. As with most other fee-generation opportunities, however, managing overdraft/NSF transactions in such a way as to improve profit and service opportunities while maintaining customer loyalty is easier said than done. There is no free lunch, and increasing non-interest income without taking unacceptable risks requires some skill—this is not about just paying more NSFs in order to generate more NSF fees! So let’s examine the new guidance more closely.
First, it is clear that this recent guidance is not a threat to the operation of discretionary overdraft payment programs. Lending services can be done in a way that is predatory and improper, but most banks don’t do it that way. The same can be said for discretionary overdraft services. The regulatory directives are mostly common sense—blueprints to ensure that ODP services are equitable and provide good value. They specify that c ustomers should be encouraged to be aware of and practice prudent financial management, customers should not routinely use overdraft services of any kind, and banks should monitor usage and proactively reach out to customers when activity exceeds prudent limits. It is important to ensure that customers:
Perhaps the most important thing in the new guidelines is that overdraft payment is a consideration, a courtesy done at the discretion of the bank , and is not a commitment on the part of the bank. Bankers have an obligation to avoid charging excessive fees to customers who are clearly out of control. This is not unlike a restaurant that must not serve excessive alcohol—some might argue about whether or not the purchase is morally correct, but few would advocate that the government should restrict all citizens’ rights to make their own choices because a few don’t make responsible decisions.
For those financial institutions who don’t already participate in an ODP program, what are the steps? The implementation process associated with discretionary overdraft services is complex, involving several areas: marketing (customer disclosures and communications), new accounts, customer service, operations, technology, compliance, risk management, collections, and financial reporting.
For starters, a bank should determine whether or not it would benefit from outside assistance. A number of core vendors have good NSF decision-matrix and CRM capabilities, and banks may be able to develop their own processes and procedures. Some will find that outside assistance is cost-effective from the standpoint of “speed to market” and from the perspective of implementing best practices that comply with the new guidelines. Consider the following:
How does a bank that wants outside assistance go about choosing a vendor? Some of the vendors out there remind me of a cousin who once joined a religion where the path to enlightenment requires you to read “the writings,” but seeing “the writings” involves first donating large sums of money to the religion. Q uality vendors will provide a detailed analysis and updates on industry developments and trends, to ensure that the processes and practices associated with their service are consistently and reliably prudent, safe and compliant at reasonable cost.
Some firms use contract labor or outside resources to implement the service or provide ongoing support. Most financial institutions would prefer not to use contract labor that will be gone as soon as the job is completed.
The implementation process should be managed by stable, experienced staff to ensure proper implementation and training, including the following:
Vendor characteristics to evaluate carefully:
At the end of the day, ODP programs will continue for three simple, capitalistic reasons: No one is forced to use such services, there are customers in the marketplace who value its benefits, and financial institutions can increase income while reducing their reliance on net interest margin.
Whether or not a bank has an ODP program in place, it will be important to thoroughly review every aspect of the existing overdraft program to ensure compliance with the new guidelines. The ODP era is here to stay.
Joint Guidance on Overdraft Protection Programs
Feb. 18, 2005
Agencies Issue Final Guidance on Overdraft Protection Programs
Federal Reserve Bank of New York Circular No. 11683
Guidance on Overdraft Protection Programs
Office of Thrift Supervision Memo to CEOs, Feb. 18, 2005