Fighting the Overdraft Privilege PR War

You have seen the news: more and more of the nation’s largest banks, including Wells Fargo, Bank of America, JPMorgan Chase and BB&T, are reforming their overdraft policies. Big whup! These changes are more window dressing than substantive, but they prove that banks—community banks and credit unions, not just The Big Guys—are losing the Public Relations war over overdraft protection fees.

There has been a significant increase in ODP fees over the last few years, as has been widely reported by pro-consumer groups such as the Center for Responsible Lending. What is also true is that much of what we used to call “regular service charges” have decreased while ODP fees increased, so the true increase in fees paid by consumers is less than consumer advocates assert. Furthermore, using statistics from the American Bankers Association, almost 82%—eighty two percent—of consumers never incur an ODP fee and would be happy to pay it if they did because they would avoid the embarrassment of having a check returned. In another study by the FDIC, almost 75% of consumers had no non-sufficient funds occurrences in a year, and another 12% had between one and four NSF items, meaning that about 87% of consumers had less than four NSFs in a year.

Now, NSF transactions trigger fees. Either the bank charges a fee for paying the item into overdraft (OD requires extra management time and risk-taking) or it will charge a fee for returning the item marked NSF (which also requires extra labor and expense). Sometimes there is a daily fee if an account remains in overdraft, because it is the consumer’s responsibility to clear overdraft conditions immediately. But consumers who do not write NSF checks or conduct ATM or POS transactions without enough money in their accounts do not pay any extra fees. What’s unreasonable about that?

So, what to do? I say fight back by getting the facts out! The media and certain consumer-rights groups have way overblown the “Big Mac” or “cup of coffee” OD charge. Most community banks have never done that, and even for those who might still do it actual occurrences are few and far between. Furthermore, since most regulatory guidance on ODP dates from early 2005, community bankers have been doing for nearly five years what the big banks are just now getting around to figuring out—following regulatory guidance and taking care of customers responsibly. Does Too Big to Fail also mean Too Big to Care About Regulatory Guidance? It would appear so, and community bankers need to distance themselves from the TBTF crowd.

The truth of the matter is that the changes these big banks are making would not generate significant revenue declines for community institutions that have been pragmatic all along—which I believe most have been.

Excessive NSF Transactions

Back in the 1970s, when I was a programmer maintaining a DDA system in COBOL in a multi-bank data processing center, one of the changes I personally installed was to add an “OD Leeway Amount” to the DDA system’s bank control file, so that a small amount (typically $5.00) was automatically added to the balance of an account when posting checks. This was done specifically to eliminate NSF/OD charges on small transactions. Later on, in the 1980s, we capped the number of NSF or OD charges that any one customer would incur in a day—at three items. The TBTF folks have now figured out what our little community bank knew over 25 years ago.

Hot checks

Consider the history of NSF and OD processing for a moment. First, consumers who write hot checks have had to pay someone for many, many years. When a check is returned NSF, in addition to the bank charges merchants charge a fee for handling that NSF check. It typically costs the consumer more to pay the bank NSF fee and the merchant’s hot check charges than for the bank to just pay the NSF item into overdraft. But when was the last time you read an article about how the bank SAVED a customer money by paying the item so that only one fee was assessed? Consider it further: Writing an NSF check is against the law. When was the last time you read an article about banks helping customers avoid legal trouble by paying their NSF checks instead of returning them?

Transaction posting sequence

Let’s discuss the sequence in which checks are paid. Thankfully, transaction posting sequence does not appear to be affected by any new regulation currently under consideration. That’s good news, because transaction posting sequence DOES make a difference—but even here the differences are not what one might expect.

First, a little more banking history. Back before there were computers, the paper transactions were generally posted in the sequence in which they were presented. Checks cashed at the teller line were posted first, since the bank had given out cash in exchange for the check, then other items were manually posted all through the day in the sequence in which they came into the bank. When computers first arrived on the scene, it became common practice to sort the “captured image” of these paper transactions into sequence by account number, transaction type and amount and post them electronically all at once overnight. Due to machine restrictions (storage limitations and computer processing power) and due to the extra manual effort required to retrieve the paper NSF items corresponding to the electronic captured images that were NSF, it was more efficient to post the smallest items first so that fewer paper items had to be handled manually the next morning.

As technology advanced and capabilities such as computerized exception item pulls were developed (where the paper NSF items were pulled out of the trays and trays of non-exception items with check sorters instead of manually retrieving them one-by-one) it became feasible to sort items in such a manner as to post the (fewer) larger items first and handle the (more numerous) smaller ones as NSFs or ODs. In my experience, that’s when the trend toward paying large-to-small began to occur, because it was now feasible to process a large volume of small-dollar paper NSF items.

Back in those days, just as today, most consumers preferred to have small checks returned rather than have large checks bounced. Its one thing to tick off Joe the Grocer and quite another to miss the deadline on one’s mortgage payment, which will cost a lot more than an NSF fee.

As part of the research for our 1980s-era changes, additional due diligence was performed. This is what we found:

• Posting in large-to-small amount sequence generates the most fees because the largest number of items are NSF.
• Posting in check number sequence (which corresponds to the order in which the checks were written) generated some 60% of the income of small-to-large. It’s hard to argue that the posting sequence is unfair when transactions are posted in the same sequence in which the checks were written, and for many commercial ODP programs that is still a best practice.
• Small-to-large generates the least in NSF or OD fees.
• The Uniform Commercial Code provides banks with wide latitude in decision-making as to posting sequence.

So, what we discovered was that when banks first automated check processing they unwittingly began posting items in the worst possible sequence from a fee income perspective even though it was in the best possible sequence from the perspective of minimizing labor cost. As technology improved, it became possible to move back toward the way items were posted before automation.

ATM and POS transactions

ATM and POS transactions are different. In the FDIC study approximately half of NSF/OD transaction took place at ATM and POS terminals. Since the bank is approving these transactions in real-time, it has the option to decline an NSF transaction before it even occurs. This is where the big banks, and some smaller organizations, have lost the PR war. With paper or ACH the bank does not have the option to decline the transaction on-the-spot—it is forced to handle it as an exception, with the associated additional handling expense. A bank is well within its rights to return a check (or to charge something for NOT returning it) in this instance.

But when a customer is at an ATM, and enough money is not in the account, and the bank approves the transaction anyway, that smacks of greed—Yes! Get that OD fee! The argument can be made that consumers should check their balance before making an ATM withdrawal, but I believe that banks should simply decline those transactions, particularly when they are for small amounts. In my experience, most consumers agree.

But what to do about POS? To decline a transaction at a POS terminal is to embarrass a customer publicly in a restaurant or at a store (as opposed to turning down an ATM transaction, which offers some privacy). I believe most consumers would prefer to have a POS transaction paid, but the research I’ve seen lumps ATM and POS transactions together (even though they are very different from a customer service and privacy perspective), so consumer preference in this area is not clear.

Conclusion

Here is the message community bankers need to get out:

1. Writing an NSF check is a consumer choice. Consumers who write hot checks will pay somebody, or several somebodies.
2. Exception handling is more labor-intensive and costly. Banks are well within their rights to charge extra when extra handling is required.
3. ODP channels fees (and write-offs) to the bank instead of to the merchant and usually reduces the total cost to the consumer. Bankers don’t need to be ashamed of collecting a fee for services rendered at a price set by the marketplace, nor do they need to be ashamed for handling matters in such a way as to reduce the total cost to the consumer (who created the NSF in the first place).
4. Most commercial ODP programs have counseled one best practice for years: avoid excessive ODP charges! They’re probably not going to be collected anyway, and they generate a tremendous amount of ill will.
5. Most reputable commercial programs recommend providing a “workout” option when excessive fees accumulate. And once an account goes into “workout,” don’t continue to pay checks or assess ODP fees.

Proposed new regs may require an explicit opt-in or opt-out provision. It’s hard to argue that that’s unfair or unreasonable. If the FDIC survey is correct, over time 87% or more of customers will opt in.

The goodwill associated with implementing most of the other “Final Guidance” promulgated on February 18, 2005 is way more valuable than the revenues foregone, and those few community bankers who haven’t done so should get behind that.

To quote a good friend who recently called me for an old-fashioned rant: “Community banks have been stupid to let the media get so much PR traction on such an insignificant issue.” We need to get the word out that ODP fees are 100% avoidable and a valuable service when they do occur. The 87% of consumers who manage their affairs responsibly will agree.
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Fee Income Best Practices

According to The Cornerstone Report 2007: Benchmarks and Best Practices for Mid-Size Banks, “Even with flat debit usage per card and declining ATM volumes, banks saw very solid growth in retail fee income between 2005 and 2007. … Clearly, the biggest reason for fee income growth was OD/NSF fees. … Most banks are not anticipating the percentage growth of OD/NSF income that they experienced in 2006/2007 – most, instead, are recognizing that the income from these programs may plateau and are budgeting accordingly.”

Here are two Fee Income Best Practices tips from The Cornerstone Report.

1. Provide reporting that shows which customers are producing the most fee income and where branch waivers still are excessive.
2. Use loyalty programs and other strategies to increase debit usage. Make increased usage a strong branch priority.

Cornerstone Advisors firmly believes “you cannot improve that which you don’t measure.”

Benchmarking lies at the heart of measurement and accountability and forms the crucial foundation for any financial institution initiative that involves process improvement, strategic planning, the implementation of best practices, efficient staffing and budgeting, and profitability improvement.

Contact Cornerstone or visit our Web site to learn about our Best Practices and Process Improvement services.