A New Framework for Overdraft Program Compliance

Transcription

1 A New Framework for Overdraft Program Compliance Prepared by the ABA Overdraft Program Task Force August 2010

2 A New Framework for Overdraft Program Compliance Prepared by the ABA Overdraft Program Task Force I. Introduction Competition in the American banking industry has driven innovation and enabled consumers to access banking services at lower and lower costs and in more convenient ways. No longer are customers compelled to select among limited account options with limited features or to maintain balances of idle funds for the privilege of conducting transactions. Similarly, as customers have taken on the responsibility to manage their accounts to the last penny, they have naturally appreciated protection against their inadvertent mistakes. This has given rise to a variety of bank overdraft accommodation practices that help ensure that a customer s transaction is completed as intended. In 2003, the American Bankers Association (ABA) joined with Alex Sheshunoff Management (ASM) to examine the origins of overdraft programs and to address the regulatory concerns and overdraft practices of the time. The result was a document, Overdraft Protection: A Guide for Bankers, that examined emerging consumer perceptions about overdraft services and industry responses to consumer expectations and behavior. The paper was intended to equip bankers to make informed decisions about what overdraft protection services to offer and to suggest industry best practices. 1 The world has changed considerably in the seven years since the ABA-ASM paper was published. Technological advances have driven increased consumer use of electronic payments as well as online bank account access. Debit card use, in particular, has dramatically increased as it has increasingly replaced checks as well as cash. Banks have responded to these changes and consumer expectations for bank accommodation of the occasional insufficient funds transaction by expanding overdraft services to cover ATM and other debit card transactions. This, in turn, has on occasion resulted in the maligned $30.00 cup of coffee and negative attention from consumer advocates and the media. Finally, the recent financial crisis and economic downturn have resulted in dramatic changes in the political and regulatory climate. ABA believes these changes warrant a renewed evaluation of overdraft practices and identification of outstanding risk management issues in light of the recent regulatory changes governing overdraft programs. ABA continues to believe in the power of industry competition and informed choice. ABA supports the Board of Governors of the Federal Reserve System s (the Board) strong but judicious amendment of Regulation E which acknowledges the value to consumers of bank overdraft accommodation practices and empowers the consumer with an informed right to choose. ABA hopes that this paper will provide all interested parties financial institutions, 1 Overdraft Protection: A Guide for Bankers, American Bankers Association and Alex Sheshunoff Management (2003), available at Indeed, these best practices were explicitly endorsed by the Office of Thrift Supervision in its subsequent guidance on overdraft protection programs. See 70 Fed. Reg. 8428, 8429 (February 18, 2005). 2

3 consumers, members of the media, and industry regulators with updated facts about overdraft practices and will facilitate the discussion, and possible resolution, of outstanding risk management and compliance issues with respect to the operation of overdraft programs. So informed, ABA believes that we can bridge the divide in the debate about overdraft protection, assured that both banks and consumers are empowered to make the right choice about overdraft protection. Banks will be free to evaluate their markets and to design and operate sustainable and responsible overdraft programs, and consumers will be assured of adequate information and safeguards to decide whether to participate in the overdraft protection programs offered and to decide which service choices make the most sense for them. II. ABA Overdraft Program Task Force In December 2009, ABA s Board of Directors established an Overdraft Program Task Force (the Task Force) to assist with the development of ABA policy positions with respect to bank overdraft services and to identify aspirational industry practices that promote the fair and ethical treatment of customers in connection with overdraft services and comply with federal regulatory obligations. ABA Chairman Art Johnson appointed fifteen individuals to serve on the Task Force, representing a cross-section of ABA s membership and two state bankers associations. The Task Force met once in-person followed by bi-monthly conference calls between December 2009 and August During its deliberations, the Task Force held discussions with representatives of the federal banking agencies, staff of the Senate Banking Committee and the House Committee on Financial Services, and representatives of overdraft program vendors in order to understand current industry practices and public concerns about those practices. The Task Force assisted ABA with the formulation of comments to agency regulatory proposals, the development of informational guidance for financial institutions on their compliance obligations under Regulations E and DD, and the dissemination of information to the public and the media on bank efforts to comply with the new overdraft regulations. In addition, the Task Force developed this report, A New Framework for Overdraft Protection Compliance. III. Findings: 1.An enduring reality: consumers value overdraft protection. In 2009, the Board of Governors of the Federal Reserve System adopted two strong rules under its Electronic Funds Transfer Act (Regulation E) and Truth-in-Savings Act (Regulation DD) authority that address the main concerns raised by Congress, regulators, consumer advocacy groups, and the media with regard to customer overdraft activity, particularly debit card transactions. 2 These rulemakings followed an extensive consumer testing and notice and comment process pursuant to which the Board recognized that overdraft accommodation 2 See 74 Fed. Reg (Nov. 17, 2009); 74 Fed. Reg (January 29, 2009). 3

4 programs provide benefits that bank customers value and for which they are willing to pay. Indeed, consumer testing has consistently confirmed what bankers know consumers want, appreciate, and expect important payments to be paid and not returned. The Board found that most of the participants in its focus groups were not surprised that banks offered overdraft protection, understood that they would be automatically enrolled, and indicated that the overdraft coverage was a positive feature for those who need it or for particularly important transactions. 3 The Center for Responsible Lending in its January 2007 survey found a similar attitude among consumers; over 92 percent, when asked, said they would like the bank to pay an item even though there were insufficient funds, and they were willing to pay something for it. 4 Similarly, ABA s survey found that of the 20 percent of consumers who had paid an overdraft fee in the last year, 85 percent were glad their bank did so. 5 There are good reasons customers value having the payment made, even it if means incurring an overdraft fee. Customers value the ability to avoid the embarrassment, hassle, costs, and other adverse consequences of having a check or automatic electronic payment returned. Whether made by check or electronically, returning a payment to a merchant, mortgage company, landlord, government agency, or utility usually means the customer pays additional fees charged by the person receiving the payment and suffers other adverse consequences. In addition to avoiding additional fees, through overdraft protection, customers avoid the inconvenience of having to resolve the issue and arrange a second payment. They also escape the risk that their landlord, merchant, or other payment recipient will in the future refuse their checks or electronic payments and insist on a cashier s check or cash. Finally, customers avoid having adverse information reported to a negative bad check database. As explained in the 2003 paper, Overdraft Protection: A Guide for Bankers, bank overdraft programs developed to accommodate this rational customer calculation. By formalizing and disclosing overdraft program features, banks provide a valuable service to customers, permitting them to make informed decisions about their options when facing the occasional nonsufficient funds transaction. Although no one wants to encourage overdrafts, banks do want to provide services that customers want and value whenever and wherever prudent. 2.Consider the role of individual responsibility. In recent years, media and consumer groups have turned their attention to overdraft programs in which enrollment is automatic and which permit consumers to overdraw at the ATM or through a debit card point-of-sale transaction, allegedly without the customer understanding that the transaction will overdraw the account and incur a fee. They assert that such programs are by nature deceptive and designed to take advantage of consumers. Noticeably absent from 3 Review and testing of Overdraft Notices submitted by Macro International, Inc. to the Board of Governors of the Federal Reserve System, December 8, See Center for Responsible Lending, Debit Card Danger, (January 25, 2007). 5 See ABA Overdraft Fee Study, Ipsos U.S. Express Telephone Omnibus, (July 11-13, 2008). 4

5 these discussions, however, is any recognition of the role of individual responsibility to manage financial accounts. The Task Force believes that the role of individual responsibility cannot and should not be disregarded in any sincere examination of overdraft practices. Consumers have a responsibility for conducting transactions within their means and an obligation to be informed about account balances. They are in the best position to know what their actual balance is; only they know what checks they have written, automatic payments they have authorized, and debit card transactions they have initiated. The bank will not be aware of checks written, automatic payments scheduled, or even some debit card transactions until they are presented to the bank. In addition, all consumers may easily avoid overdrafts and the vast majority do by keeping track of account balances, maintaining a cushion in an account, linking to another account such as a savings account or overdraft line of credit, or requesting low balance alerts. The Task Force believes that it is important not to reinforce the incorrect and harmful notion that consumers may assume that institutions are aware of all transactions that the consumer has authorized and that it is not necessary for consumers to keep track of account balances or use other available options to manage their accounts. 6 Indeed, the Board s amendments of Regulations E and DD clearly acknowledge the role of informed individual choice and responsibility. 3.The new regulatory framework empowers the consumer. Amended Regulation E provides that depository institutions may not impose an overdraft fee for ATM and one-time, point-of-sale debit card transactions unless the customer expressly consents or opts in to the overdraft program. In order to ensure meaningful consumer consent, the regulation establishes a prescriptive notice and consent regime complete with a model notice that institutions are cautioned against modifying significantly. Perhaps even more noteworthy than the opt-in provision is the freedom guaranteed by the regulation for customers to revoke their opt-in at any time. 7 Customers may change their mind at any time without consequence or cost. The Board could not have fashioned a greater flexibility in consumer choice than it has in Regulation E s freedom to opt-in and opt-out at will. Moreover, the requirements of amended Regulation DD augment Regulation E s consumer flexibility by providing consumers with clear disclosures on periodic statements of all NSF and overdraft fees. In addition, Regulation DD requires that institutions only disclose funds available for immediate use excluding funds available through linked accounts, an overdraft line of credit, or an overdraft program when disclosing automated account balances to a consumer. 8 6 Moreover, managing the account is not only important for avoiding overdrafts, but also for controlling spending and protecting against identify theft and fraudulent activity C.F.R (b) C.F.R

6 4. Banks have expended considerable effort to comply with the new regulatory framework. The new rules have engendered significant business model adjustments, operational changes, and customer communication challenges in a relatively short time period. Many institutions have re-evaluated their decision to offer standard overdraft services. Some institutions have discontinued offering debit card overdraft services, while others have introduced it. Those choosing to offer debit card overdraft services had to ensure that significant changes to core processes were made in order to distinguish recurring debit card transactions from one-time debit card transactions. They also had to establish procedures to record and track opt-in and revocation decisions, to train employees, and to design customer outreach materials to explain the impact of the new rules to customers. Even those institutions that did not knowingly pay debit card overdrafts had to make adjustments and incur costs to ensure that fees are not charged for one-time debit card overdrafts that the institution cannot avoid. It is clear that all institutions have had to expend considerable amounts of time, energy, and money to design responsible, sustainable, and compliant overdraft policies, practices, and customer outreach materials consistent with the new regulatory mandates. It is also clear that these business model and operational changes mean that the current state of overdraft services across the industry is relatively unknown. At this point, no one has a clear picture of the prevailing practices and account features banks will offer their customers. Similarly, consumer response to overdraft opt-in notices is, at this point, an unknown. Consumers have been receiving communications about changes to overdraft programs and their overdraft options. While many may be prepared to make an immediate decision, others will wait until circumstances drive them to make a choice. Accordingly, the banking industry does not yet know the compliance issues, if any, that will need to be addressed. The Task Force wants to underscore this fact and to urge all involved in the continuing consideration of overdraft practices to permit banks and consumers to assimilate and react to the changes already implemented before calling for further regulatory or legislative action. IV. Promoting Responsible Risk Management Practices. During this period of implementation and for its reasonable aftermath, the Task Force believes there is value for the banking industry and its customers to identify risk management challenges with respect to the operation of overdraft protection programs and, where possible, to encourage practical and responsible methods to address those challenges and achieve the policy objectives intended by the Board s regulatory initiatives. By doing so, the Task Force does not intend to propose industry standards, but rather to illustrate risk management considerations that can help banks evaluate their legal obligations, the latitude preserved for their business discretion, and their market conditions, and use this information to design their own sustainable overdraft services and provide transparent choices that deliver value to consumers in a responsible manner. We believe that this process will yield a wide range of overdraft protection programs that fairly address consumer needs and promote free choice and 6

7 healthy competition, essential elements of a sound financial services market, and allow for further development of attractive options for customers as technology and customer needs change. A discussion of risk management practices follows: 1. Implement programs compliant with new regulatory framework. The primary focus of bank risk management practices with respect to overdraft protection programs should be to adapt to the new regulatory framework established by the recent amendments to Regulations E and DD. This involves not only achieving law abidance, but also exercising the discretion afforded by the new regulatory framework in a responsible manner. Together Regulations E and DD set forth standards for baseline practices and customer communications. Some of these standards elevated previously aspirational best practices to regulatory requirements. The baseline practices are: Do not impose overdraft fees due to non-recurring debit card transactions without affirmative customer consent ( opt-in ) to participate in the bank s standard overdraft service coverage. Promptly retract standard overdraft services coverage for non-recurring debit card transactions when customers revoke their opt-in or otherwise make clear they do not want to continue receiving the service. Do not discriminate in the provision of services or account features among customers receiving the same account type on the basis of their election or non-election of standard overdraft services. The requirements for customer communications are: Deliver a notice to all customers of their right to opt-in to standard overdraft services for non-recurring debit card transactions. Include in any notice of right to opt-in a description of alternative choices for overdraft protection made available by the bank. Provide written confirmation to each customer of an election of standard overdraft services coverage. 7

8 Clearly describe standard overdraft services and fees in account documentation and associated materials to ensure the discretionary nature of the service is explained and the cost of use is evident. Disclose the fee(s) associated with standard overdraft services when such services are referenced in advertisements. In account periodic statements, provide a disclosure of monthly and year-to-date overdraft and non-sufficient funds fees. Disclose in any overdraft service promotion certain information, including the amount of the fee and the types of transactions covered. 2. Conduct programs that reasonably empower customers to take responsibility for their financial activities. Regulation E and DD taken together are a strong endorsement of individual consumer choice and responsibility. They place in the hands of each and every customer the power to affirmatively elect overdraft protection for non-recurring debit card transactions and the information appropriate to make and manage that choice. The regulatory amendments reinforce the already robust conclusion that overdraft fees are undoubtedly reasonably avoidable by a customer acting responsibly under ordinary circumstances. After all, not only are customers able to manage their accounts to avoid incurring overdraft fees; they are now fully empowered to freely elect or reject services that would expose them to overdraft coverage for one-time debit card transactions and the associated fees. Consequently, bankers operating their programs should consider how they depend on and promote individual customer responsibility. Such considerations might include, for example: Designing a marketing strategy to foster communications with customers that accurately reflect the value proposition that the bank s standard overdraft services offer and avoid resorting to fear mongering or materially exaggerating the benefits of coverage that could mislead reasonable consumers about the continuing importance of their individual account management responsibilities. 9 Monitoring customer usage of overdraft services to enable the bank to offer alternatives that address customer needs and financial management capabilities. 9 ABA provides two Bank Stuffers that can contribute to bank efforts to leverage individual customer financial responsibility: New Overdraft Rules fir Debit and ATM Cards, a pamphlet built from the Board website that explains the rights of customers under amendments to Regulation E and DD; and Understanding Overdraft Options, a guide that updates the Interagency brochure that was released in 2005 to help customers better manage their accounts to avoid unnecessary overdrafts. See 8

9 Evaluating technical and process advances (like balance and overdraft e-alerts) when they can be cost effectively incorporated into program features to help customers make informed judgments about account management. 3. Observe other applicable consumer protections. In addition to Regulations E and DD, other consumer protections apply to overdraft protection services and plans and must be incorporated into the bank s compliance risk management efforts. For example: Certain aspects of standard overdraft services are covered by Regulation B to ensure that an overdraft program is not administered in a way that discriminates on a prohibited basis. Reports about account status to consumer reporting agencies are subject to updated requirements of the Fair Credit Reporting Act and must be accurate to reflect the distinction between overdrafts that are paid as agreed under the terms of the account and those that are not repaid as agreed. 4. Keep sight of the safety and soundness implications of your overdraft program. A cornerstone of the 2005 Interagency Guidance on Overdraft Protection Programs (the 2005 Interagency Guidance) was a discussion about managing overdraft protection program safety and soundness. 10 This continues to be an important risk management element in the current environment. We agree that institutions should consider including within their overdraft policies and procedures express account eligibility standards; well-defined, objective dollar limit decision criteria; provisions governing the suspension of overdraft services when a customer no longer meets eligibility criteria; specific time frames during which a customer is expected to pay off an overdraft balance; and charge off criteria for uncollectible overdraft balances. The current regulatory and economic environment, however, also suggests that banks factor into their evaluation of other safety and soundness considerations: The significance of revenue received from overdraft protection services within the bank s overall financial picture. The ability to manage the bank s reliance on earnings from overdraft fees given competitive pressures, regulatory or legislative uncertainty, and changes to customer behavior with respect to exercise of protected opt-in and opt-out rights. 10 See 70 Fed. Reg (Feb. 24, 2005); 70 Fed. Reg (Feb 18, 2005). 9

10 5. Exercise business discretion regarding overdraft programs responsibly. Equally important as the mandatory practices imposed by Regulations E and DD are the practices left to the business discretion of the bank. There are three particular areas left to this realm of discretion by the new regulatory framework that are worth further discussion: Standard overdraft service features not regulated by the amendments to Regulations E and DD such as pricing, payment processing order, and handling of debit card transaction holds when authorization and settlement amounts vary. Standard overdraft services covering transactions other than those conducted as one-time debit card transactions. Overdraft protection plans. This discretion, however, is not unlimited. Banks operate in a heavily regulated and supervised market and are subject to particular public and media scrutiny. There are several risk elements that the bank must manage carefully when exercising its discretion and multiple ways to do so. The resulting industry diversity produces a range of market choices for consumers all of which meet regulatory requirements and afford reasonable value to those seeking protection from inadvertent overdraft activity. Ultimately, a bank s exercise of discretion should be approached as a matter of sensible enterprise risk management that comprehensively addresses operating, financial and compliance risks while also safeguarding the bank s ethical standards, franchise value, and reputation. Therefore when exercising business discretion, the bank may want to ask the following questions: Is the overdraft program one that the bank honestly feels can be understood and managed properly by members of the community acting reasonably under circumstances of prudent account management? Do members of the community view our overdraft program favorably as a service that benefits customers and contributes to their desire to patronize the bank? Would publicity of how the bank operates its overdraft program adversely affect the community s perspective about the bank? Is the bank adequately explaining to customers and the general public its overdraft programs? 10

11 6. Leverage informed consumer choice to diversify program features. A corollary of the new regulatory framework s endorsement of consumer choice is the responsibility of consumers to make rational comparisons between the value derived and the price incurred for the overdraft coverage received. Moreover, banking is not different from other service industries in which economic success is predicated on delivering customer value at a price people accept. Responding to these facts, banks have recognized that they can compete for customers by providing more options than the simple coverage on or coverage off election. In other words, banks can incorporate within their overdraft programs design elements that make consumer choice more competitive by offering more options to meet the variety of consumer preferences. For example, banks can and have introduced daily and/or monthly aggregate limits into their standard overdraft services without any regulatory mandate. They can and have established thresholds under which a transaction or its associated overdraft amount will not incur an overdraft fee again without any regulatory mandate. These examples of bank discretion reasonably exercised will not likely be attractive to all customers in all situations and carry pluses and minuses (as do all services) but they are just two of several illustrations that flow from the empowerment of consumer responsibility to make and manage an informed choice and the competitive response that is generated by business risk management strategies intended to leverage such customer choice. 7. Be circumspect when disclosing information about processing order. The 2005 Guidance recommends that institutions explain generally that transactions may not be processed in the order in which they occur and that the order of presentment, processing and settlement may affect the total amount of overdraft fees imposed. This recommended practice of providing general information alerts the customer to the uncertain contingencies that impact overdraft experience, but does not overload them with detailed and lengthy information about complicated clearing and settlement processes that confuse consumers and discourage review. Moreover, providing such information should not induce unwarranted efforts to game the system. 8. Establish debit card hold policies to balance customer convenience and risk mitigation and encourage payment system efficiencies to reduce delays in clearing account holds. Banks are dependent on the network systems that enable debit card transactions and the practices of the merchants who use them. These systems and practices present certain risks to banks, including risks that arise in the time period between authorization and settlement, especially when the authorized amount differs from the settlement amount, as in the case of a gasoline or dinner purchase. Banks must manage these risks prudently. They necessarily strike a balance between customer convenience and risk mitigation through the use of debit card transaction hold policies. Many banks hold less than the amount permitted under network rules so as to minimize any inconvenience to their customers. In the case of gasoline purchases, many place no hold or a hold based on the average transaction amount. 11

12 As an industry matter, banks encourage merchants to adopt payment system upgrades and other changes so that their transactions settle faster and delays in removing customer holds can be eliminated. In addition, banks encourage merchants to post signs advising customers of possible holds at the point of sale as this is the time and place where customers are most likely to notice and review it and can make a more informed decision about which payment method to use. 9. Manage offerings among various standard overdraft services and other overdraft protection options to facilitate informed customer choice. By drawing this boundary in the framework, the Board recognized that alternative overdraft services and plans such as overdraft lines of credit and linked savings accounts are already adequately regulated and that customers do not experience problems that warrant further intervention in the operation of such programs. Going forward, banks should continue to manage these alternative overdraft plan options to maintain informed customer choice. Customers should be aware of and understand the various overdraft coverage options so that they may make the choice best suited to them and use responsibly whatever overdraft service or plan they select. Their ability to choose different options should be preserved and encouraged by the bank s risk management practices and pertinent customer communications. By monitoring for frequent overdraft service users, banks are in a better position to manage their customer relationships, to offer account management guidance, and to determine whether other available overdraft options might be appropriate for them. We note that prescriptive regulations can actually reduce the range of choices that consumers find attractive and discourage development of new options as technology and consumer preferences change. V. Conclusion ABA s Overdraft Protection Program Task Force concludes that the new regulatory framework for overdraft protection programs creates a strong pro-consumer baseline that preserves and promotes the customer s ability to make an informed affirmative choice when seeking overdraft coverage. We believe that our members can apply sound risk management principles that reinforce the policies of the framework and encourage customers to conduct their account transactions responsibly. We are confident that the industry will implement the new framework fairly and will continue to deliver valued services to meet customer needs responsively and transparently. We call upon policy makers to preserve a regulatory environment that allows banks to continue to compete to offer services that better meet our customers changing needs and preferences and that allow us to develop new services made possible by changes in technology. 12