Consumer Finance Client Alert - CFPB Proposes New Rule on Overdraft Practices < Articles < News

Consumer Finance Client Alert – CFPB Proposes New Rule on Overdraft Practices

By Frank A. Hirsch, Jr., Consumer Finance

On January 18, 2024, the CFPB proposed an extensive (211-page) rule on overdraft practices applicable to Financial Institutions (FIs) of $10 billion or more in assets (so called “very large FIs”). The proposed rule would not affect the OD-NSF practices of FIs less than $10 billion – which includes over 4,000 banks and almost all but the largest 20 credit unions in the United States. Despite the excluded FIs, the proposed rule would cover 80% of consumer deposits nationwide and 68% of all OD fees charged. This alert highlights the major proposed changes.

A. Scope and Timetable

The CFPB proposes the new rule under its authority per the Truth in Lending Act (TILA) (and Reg. Z), the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act), the Electronic Funds Transfer Act (EFTA) (and Reg. E), as well as the Consumer Financial Protection Act (CFPA). Comments on the rule are due before April 1, 2024, and the rule might be implemented as early as October 1, 2025 – although significant industry pushback is expected.

B. Major Changes

The rule, at a high level, seeks to make eight significant changes:

Almost all OD fees are no longer exempt from TILA or the EFTA;
OD fees are capped either at the FIs actual cost to provide such “credit” (without the inclusion of any profit) – the so-called “breakeven standard”, or at the CFPB’s “benchmark fee” amount;
The CFPB will annually set the benchmark fee and proposes an initial cap of either $3 per OD, or $6, $7 or $13 – depending on various formulas the Bureau has recently developed from studying five of the largest banks’ recent OD data;
Reg. Z account-opening disclosures, periodic statements and advertising rules would apply;
If hybrid debit-credit cards are used for the OD – the CARD Act protections would apply – including ability-to-pay underwriting, limitations on penalty fees – including NSF fees – and protections against rate changes;
A prohibition on compulsory use of pre-authorized electronic funds transfers (EFTs) for the repayment of ODs;
The requirement that ODs be handled as a separate account from checking accounts and a prohibition on auto deduction of all OD amounts from the next deposit received by the consumer; and
The consumer’s right to pay separately for any OD fees by the methods they choose.

C. Current Status of the Changing OD Fee Market

The proposed rule acknowledges that significant changes have occurred in the OD fee practices for FIs – especially since 2019 as a result of actions by the CFPB – and banks (mostly large banks) amended practices concerning the elimination of NSF fees, the reduction of the OD fee amount, grace periods for repayment, exception of de minimus amounts from ODs, and caps on the frequency of OD fees – among other altered practices. Despite such market movements – the CFPB contends that OD fees remain too high and unjustified.

The CFPB characterized the market at present as a “back-end pricing business model” which has become automated and no longer resembles occasional courtesy payments for consumers. Between 2004-2009, OD fees ballooned from $10 billion to $25 billion. But OD fees declined based on EFTA Reg. E opt-in requirements for debit card and ATM transactions in 2010. Then, by 2019, OD fees had rebounded to $12.6 billion. After a drop caused by COVID pandemic funds – OD fees exceeded $9 billion in 2020 and 2021. Market-wide OD revenue in 2022 was $7.9 billion in 2019 dollars – a 37% drop in real terms. The rule recites that recent CFPB Call Report data estimates that consumers paid $5.98 Billion in OD fees to the very large banks and credit unions.

In a recent press release by the CFPB, the Bureau estimated that the elimination of NSF fees by most large banks had saved consumers at least $2 billion in charges – on a going forward basis. Consumers have already saved significantly more than $2 billion from the FI’s other amendments to OD programs, but the CFPB wants much more.

D. Potential Impact of the OD Fee Caps

The rule estimates that a $3 OD fee cap would save consumers $5.6 billion annually (using 2022 as a baseline). By contrast, an OD fee cap of $6 would save $5 billion annually, a cap of $7 would save $4.8 billion annually, and a $14 cap would save $3.5 billion per year.

The CFPB reports that the average OD fee amount has decreased somewhat – at $32.50 per institution – but the rule proposes it be lowered to at least $14 as the benchmark.

That represents a reduction by $18.50 on average – or a mandated decrease of at least 57%. This change would impact some large FIs more than others. Capital One, Discovery, SoFi, US Bank, Citibank, Ally, and PNC charge no overdraft fees. Also, Truist and Wells Fargo do not charge fees for ODs when there is a linked savings account. Thus, if the benchmark is set at $14; then some FIs will see little change. Other FIs have already priced ODs at or near the $14 potential benchmark. Bank of America has reduced OD fees to $10, Huntington, Manufactures & Traders, and Green Dot Bank are all at $15, and Arvest Bank is at $17.

E. Varying Calculations of the Benchmark OD Fee

The rule proposes to use one of four different methods to calculate the true cost of overdraft services and thus to set the benchmark OD fee. Each of the proposed benchmarks apply the same calculation method utilized for the break-even standard. The formula in general is (total charge-off losses) plus ($1 per transaction for per OD transaction estimated cost of funds and operational costs) and dividing this sum by the total number of OD transactions.

When all ODs transactions are used as the data point – including transactions which resulted in a fee as well as those that did not trigger a fee – then, the charge-off loss per transaction produces the $3 benchmark. When counting only the OD transactions which actually resulted in a fee, the benchmark increases to $6. The $7 benchmark results from using the cost data of one bank which had the highest charge-off losses for its OD program. Counting all transactions, whether generating a fee or not, this produces a $7 benchmark. Finally, the $14 benchmark was determined again using the one institution with the highest charge-off losses but calculating only the OD transactions which actually resulted in fees.

F. What The Rule Does Not Analyze

A recited primary reason for the proposed rule is to allow informed consumer choice as to OD practices/fees. But many frequent overdraft users appear to knowingly choose the OD feature, even though the cost of credit is high (as recognized by the CFPB December 18, 2023, report. And with the proposed rule setting either a break-even figure or a benchmark figure for OD fees (utilizing the same calculatory methodologies), then consumer choice is materially eliminated. The pricing for the OD product is capped. Consumer choice will be relevant only to remaining elective features of OD programs – de minimus levels, grace periods, repayment options and fee waivers – or any re-priced costs for checking accounts, debit cards or ATM privileges.

The proposed rule raises a number of questions:

If the proposed caps on OD fees are implemented, why won’t FIs just tighten underwriting for the product and require linkage to deposit account OD minimal credit lines and squeeze the frequent OD users out of this type of credit?
Could the proposed rule drive significant numbers of consumers into the ranks of the “unbanked”?
Could rejection of transactions for insufficient funds trigger higher stigmas for frequent users and lower credit scores?
Could the proposed rule drive more consumers to utilize buy-now-pay-later (BNPL) providers – which the CFPB has separately opined present unclear or unfair terms to unaware consumers?

In the CFPB’s September 22, 2022, Report on BNPL practices, the Bureau noted that consumers are harmed by such products in at least five material ways:

the providers lacked standardized cost of credit disclosures required by TILA and Reg Z;
BNPL lenders did not provide billing dispute and error resolution rights required by Reg Z;
compulsory use of autopay in making payments to BNPL lenders violates the EFTA and Reg E;
multiple payment re-presentments were common which trigger fees ($7) and some triggered OD fees by the banks where consumers had accounts; and
multiple late fees were sometimes applied to the same missed payment in violation of CARD Act “reasonable and proportional” limits.

It remains to be seen how and when the CFPB plans to intervene in the fast-growing BNPL marketplace to close the compliance gaps already identified.

Conclusion

The financial services industry will push back on the proposed rule but may have to resort to litigation to prevent implementation. For the plaintiffs class action lawyers, the proposed rule is a greenlight to resume attacks on OD fee practices of FIs. And 2024 as an election year could cause disruption in the policies being pursued by the CFPB. Lots of uncertainties exist. Stay tuned for more developments.