Op-Ed/Viewpoint
OVERDRAFT PROTECTION: SERVICE OR BURDEN TO ACCOUNT HOLDERS?
ODP a win-win situation for customers and financial institutions; room for improvement exists.
In this Op-Ed piece, John M. Floyd, CEO of John M. Floyd & Associates of Houston -- which has implemented variations of its Overdraft Privilege programs in more than 400 banks, thrifts and credit unions -- discusses account overdraft programs (a.k.a. as bounce protection) offered by financial institutions. Overdraft is getting broad national coverage, since it is being protested by a coalition of 50 consumer groups and the National Consumer Law Center.
Floyd agrees some of the complaints are valid, and he speaks candidly about those abuses while emphasizing the multiple advantages of overdraft to consumers, merchants, banks and even the Federal Reserve System.
Op-Ed/Viewpoint
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OVERDRAFT PROTECTION: SERVICE OR BURDEN TO ACCOUNT HOLDERS?
ODP a win-win situation for customers and financial institutions; room for improvement exists.
By John M. Floyd
An interesting debate is emerging in the national media, which questions whether banks, thrifts and credit unions are beneficent saints or gold-digging sinners in offering their account holders and members overdraft privilege (ODP). Consumer groups and some journalists are even calling for regulatory investigation and intervention. (Some Banks Encourage Overdrafts, Reaping Profit," New York Times, Jan. 22, 2003.)
From my 30-year perspective as both a banker and a consultant to financial institutions and financial services firms in the United States and Central America, ODP issues are neither all black nor all white. They are certainly about avoiding red, however, as in red ink, both by customers and bankers.
Overdraft privilege programs cover checks written by customers of financial institutions -- checks that would otherwise bounce due to insufficient funds (NSF). This privilege often extends to customers A.T.M. accounts and debit cards. This service is actually structured for institutions to allow its account holders to overdraw their transaction accounts, subject to pre-established limits. The overdrawn account must return to a positive balance every 30 days.
More than 1,500 U.S. financial institutions out of an estimated 18,000 in this country offer such defined and communicated" programs. More of them are commissioning Efficiency & Income Studies and Sales & Service Implementation Programs to evaluate customer perceptions, potential profitability and marketing strategies.
With a soft economy persisting and lending activity off sharply, bankers are looking to non-interest income to strengthen their bottom lines. Overdrafts are, indeed, among consumer fees that bolster profitability. An institution with ODP generally increases its NSF income by 50 to 200 percent.
Most bankers offering them see ODP programs as an absolute win-win situation for institutions and their customers. An Indiana community banker, for whom my firm assisted with an ODP program three years ago, makes a good case for accountholders acceptance of the program:
Our customers have been very pleased with our (ODP) program. In fact, we occasionally get thank you notes from them. They really appreciate the fact that their (NSF) check doesnt get returned to a retailer they frequent, embarrassing them and putting them on a `bad check list. They feel it saves their reputation. It also means they dont pay a hefty fee to that retailer."
One wonders, then, why more financial institutions have not already installed ODP programs? Many bankers and their board members share the misconceptions that ODP software is not compatible with their institutions core processor. Others think ODP will be too much trouble in dealing with added compliance issues and operational procedures, including systems implementation, employee training and launching strategic marketing campaigns. Some fear attracting the 'wrong" type of account holders.
Ironically, it is those very account holders, typically underserved low- and moderate-income earners, who need the help of financial institutions to manage their funds and cash flow within the safety of a bank account, instead of carrying or hiding cash. While every financial institution wants rich account holders, the competition is fierce and time consuming. That suggests community financial institutions, particularly, can do a better job of meeting the needs of their broader account holder base. But those same patrons, while enjoying a beneficial service, can make money for all the banks, thrifts and credit unions.
Customers of ODP enjoy multiple benefits. They simply pay the financial institution one fee per NSF-paid check, rather than the one or two fees to the financial institutions as well as bad check charges" to the retailer. Simple math says $25 is better than $75 or more in charges. Discreet customer service support avoids the humiliation of making good" on a check with a valued retailer, and avoids the lost time and productivity of both the customer and retailer in straightening out an NSF mess" . . . or answering to law enforcement! Additionally, free checking is often offered in conjunction with ODP plans.
A leading Florida credit union executive noted, "Our members have enjoyed the convenience of having access to overdraft funds for emergency purposes, before payroll deposits are available, or to pay bills to avoid late charges and negative credit history."
Fact is, many Americans live from paycheck to paycheck. Many do not have the desire or time to pursue a line of credit, nor would they qualify. As they struggle to pay bills or to save anything at all, they need a financial institution that understands how they live their lives and provides a valid safety net with such programs. Some banks even view ODP as a way to rehabilitate" customers who have consistently bounced checks in the past.
A Central Texas banker with an ODP program for the past five years, wrote: We shifted into a bit of credit-counseling mode, helping our customers understand the new process and how to better manage their accounts. I would guess nine out of 10 customers have said they appreciate ODPs benefits."
ODP is a financial incentive (to institutions) to allow these customers to overdraw," one Kentucky banker told me. It can mean robust results...." The banker conceded charge-offs for bad accounts had increased, but were acceptable in relation to the new income, and that account turnover had actually slowed because the service had solidified the banks relationship with its customers
Questionable ODP Practices
Demand Industry and FRB Attention
Financial institutions have been paying accountholder overdrafts since the beginning of banking. Smart financial institutions do not promote poor fiscal responsibility. Call an overdraft charge a fee or a penalty, an insurance policy" or a punitive wake-up call," if you must. But the fact that a population segment finds it less onerous than returned checks, lines of credit and blemished credit records, does not make it inherently bad.
Nevertheless, financial institutions must responsibly deploy such programs, educating and frequently reminding customers of the terms and use of overdraft privilege, while avoiding messages that essentially encourage customers with low balances to overdraw their checking accounts.
A few institutions, some due to a lack of technology, make it a practice of including the ODP limit in the customers available account balance, without informing them. The customer inadvertently writes a check and triggers one or more charges. More customer education would be helpful.
Historically, financial institutions have provided selective overdraft payment for their preferred" account holders at the institutions discretion. Such institutions describe these relationships as informal," but most institutions do it consistently for the same accounts -- without noisy external promotion. Often there is no regard to the NSF item amount., and no NSF or overdraft fees are assessed.
Some ODP providers deliver a discriminatory form of the service described above, marketing them as premium" or platinum" services, while excluding the average account holders from participation. Since account eligibility is not published in the above scenario, and exclusion occurs in the premium programs, both are correctly characterized as preferential and both are blatantly discriminatory. On its face, that is a partisan standard.
Stable account holders who occasionally run short between paychecks are assessed NSF fees, pay a penalty at the merchant and are still responsible for uncleared items. The financial institutions employing such policies unfairly disenfranchise these persons. In effect, they chastise the deadbeat" for poor financial management, while premium" customers enjoy much better treatment.
A carefully instituted ODP service, never forced on customers, avoids many of the ills of spottily applied NSF programs and policies, while conveying the previously outlined benefits. Still there has to be some distinct categories of exclusion such as dormant accounts, minor accounts and savings or money market accounts -- not wholesale redlining."
Our firm has responded similarly to the Federal Reserve Systems 12 CFR Part 226 which sought comments on Docket No. 4-1136 (by Jan. 27). The Federal Reserve Board is appropriately looking into the validity and practices surrounding NSF and ODP programs utilized by U.S. institutions. I personally hope the regulatory authorities will recognize the clear benefit of providing overdraft privilege to a broad base of financial institution customers in a non-discriminatory manner.
Conclusion
The advantages and shortcomings of Overdraft Privilege Programs will not be resolved in the press. An intense national discussion is both warranted and healthy, whether the economy is galloping ahead or dragging its feet. Financial executives need to proceed cautiously. Customers need to use ODP wisely, not habitually. The financial institutions industry must take necessary steps to prevent the practices that might keep an otherwise beneficial and legitimate service from maximizing its value to both customers and the institutions that offer such programs.
John M. Floyd is CEO of John M. Floyd & Associates of Houston, a consulting firm to more than 1,400 financial institutions in the past 26 years, and a recognized leader in ODP programs. He welcomes comments or contact at 800-809-2307 or by e-mail through the Web site, www.overdraftprivilege.com
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