Regulation E and Overdrafts: Unintended Consequences?

Posted by Anthony Demangone

Editor's apology: This is a long post.  Especially for a Friday.  But I think it is important enough to merit the length.

Yesterday, the Federal Reserve held a tele-conference to offer guidance about recent amendments to Regulation E that affect overdraft protection programs. You can access the presentation materials here. 

The teleconference revealed a very important, and potentially costly, clarification.  But first, let me give a wee bit of background.

In short, the changes to Regulation E will mean that after July 1, 2010, you may not charge a fee when a non-recurring debit card or ATM transaction overdraws an account unless you have given that member disclosures describing your overdraft program - and the member opts in.  Again - unless the member opts in, you will not be able to charge a fee for such debit card and ATM transactions that overdraw an account.

There is an exception, though.  If your credit union has a policy that it only pays those non-recurring debit card or ATM transactions when funds are available when the authorization comes in, you will not need to comply with the opt-in requirements.  But does that exception allow you to charge fees as well, or just it just relieve you from the notification and opt-in requirements?  And that's a bid deal.

Even for credit unions that do not have overdraft programs and fit within that exception, some non-recurring debit card and ATM transactions will sneak through.  Examples?  Your ATM network goes offline and the member makes a withdrawal that exceeds the account balance.  Or the gas station only sends an authorization through for $1, before the member pumps $100 of gas into his Hummer.  Collectively, I'll call these "gas station" transactions. But, the exception still stands.  You don't have to comply with the opt-in requirements in order to process them.  If you can charge fees for those, that's a good deal of revenue.  If not, you might have a big revenue hole to fill.

Here's the clarification that caught everyone's attention.  You'll find it on pages 14 and 15 of the Fed's presentation via the link above.  The exception is only for the opt-in disclosure.  The exception does not allow you to charge a fee. The presentation clarifies that there is no exception that allows a credit union to charge a fee for any non-recurring debit card or ATM transaction that overdraws an account.  You to have the opt-in.  So, for the "offline ATM" transaction, or the "gas station" transaction that takes the account negative, you cannot charge a fee without that opt-in.

Enter Troy.  I don't know who Troy is, but his question summed up everyone's frustration.  You could practically hear his teeth grind as he spoke.

His bank does not have an overdraft program.  They do not pay any transaction unless funds are available when the check, ATM transaction or debit card authorization comes in.  So he fits within the exception.  His bank does not have to send the "opt-in" form to its customers.

But his bank has charged, and wishes to continue charging, a fee when those "gas station" transactions hit accounts.  Those transactions take accounts negative, and he wants to charge a fee to mitigate the risk of the negative account.  How does he go about charging that fee after July 1. 

One of the Fed speakers said to use the opt-in form.  But Troy correctly pointed out that an opt-in form won't really work, because what would the member be opting into?  His bank has no choice but to clear the "gas station" transaction, even if the member does not opt in.  The member is really only opting into the fee! 

The other Fed speaker paused, and said that they just never considered that a financial institution would want to charge fees for "gas station" transactions. (As my colleague Steve said during the training session, perhaps the Fed should spend a little less time on consumer testing, and spend a little bit more on learning how our industry does business.)

Troy followed up and said that this whole debacle has created an unintended consequence.  Credit unions or banks that want to charge fees for "gas station" transactions may have to consider creating a full-blown overdraft protection program for debit and ATM cards.  Something Troy does not want to do. 

We're sending a letter to the Fed to underscore our concerns on the subject.

Happy Friday, everyone.

Editors's Note: Reportedly, the Fed will issue some clarifying guidance on this issue in January.

Comments

[Sue Olmstead]

I'm with Troy on this one. We do not offer courtesy pay; however, we do have members that use their debit cards at the gas station. The gas station places a hold of $1.00 and then the member proceeds to use the funds that are not being held. Once we approve a transaction, we post it. The member then overdrafts and incurs a fee. I'm wondering if we are going to have to stop allowing members the privilege and convenience of using their debit card at the gas station.

[Jason Clarke]

At the risk of being labeled a conspiracy theorist: I think this is an INTENDED CONSEQUENCE. The idea of the Fed being that individuals should not be charged fees for small transactions, but that we all have an inalienable right to consume a cup of coffee for which we cannot pay. That is why they never contemplated that institutions would need to charge a fee on these types of transactions. It is the Wimpie legislation. I'll gladly pay you Tuesday for a hamburger today.

I also wonder if anyone there has looked at what interchange legislation, the centralizing of check processing, and the restriction of overdraft on debit cards is going to do to the way a certain segment of society pays for stuff. CUs and banks will have to re-evaluate to whom they give debit cards. Those that don't qualify are the very people that will begin bouncing checks to merchants who formerly benefited from the guaranteed funds the debit card represented. Merchants will see a rise in the number of checks that are written to them which will correspond to a rise in cost as they process those checks and attempt to collect on the bad ones. The shortened hold periods will make checks even more attractive to some consumers. Those who need (or prefer to use) overdraft privilege will notice that their checks are paid and their debit card transactions are not.

Le cheque est mort. Vive le cheque.

[Southernmost Sue]

Troy is my new hero.

[Glen Shimada]

I'm with everyone that was listening in on (not presenting) the audio conference yesterday. The Fed needs to listen a little more to the industry commenters and understand how financial institutions will be impacted by these changes that they make. After reading the regulation summary, it seems that the Fed thinks that we are the deep pockets that can be made to suffer the brunt of any changes in the interest of “consumer protection”. There was a woman on yesterday’s call that summed it up perfectly, we are now being tasked to manage our members/customers and bear the cost of doing so.

With that being said, I believe that the unintended consequence noted above stating that, “Credit unions or banks that want to charge fees for "gas station" transactions may have to consider creating a full-blown overdraft protection program for debit and ATM cards”, is slightly off base. Coming from an institution that has a full-blown overdraft protection program, we would be unable to charge fees for these similar transactions as well. I believe the unintended consequence or intended consequence is that we will have to suffer additional risk and reduced income by having to pay these items and not being able to charge for them.

I understand the intention of the regulation is to prevent members from overdrawing their account based on their actual balance plus any overdraft allowance. Therefore, my interpretation of the rule change suggests that we cannot approve a one-time debit transaction or ATM withdrawal based on this overdraft allowance. I can understand this argument. However, I do not understand and do not agree with the requirement of not charging members who overdraw their accounts under “normal circumstances” (without the overdraft allowance). I think the Fed got it wrong here.

My question to the Fed on behalf of Troy and others who don’t have a overdraft program, would be, “who interpreted the exception to exclude not being able to charge the accountholder the overdraft fee?” According to the regulation, 205.17(b)(4), it states that the requirements of 205.17(b)(1), which starts off, “…a financial institution holding a consumer’s account shall not assess a fee or charge on a consumer’s account…”, do not apply to an institution that has a policy and practice of declining to authorize and pay any ATM or one-time debit card transactions when the institution has a reasonable belief at the time of the authorization request that the consumer does not have sufficient funds available to cover the transaction. The exception paragraph includes the section on the assessment of fees. Perhaps a shorter and more direct question would be, “Why is the Fed forcing institutions who do not have overdraft programs to comply with the regulation that is obviously aimed at protecting consumers from overdraft programs?”

[Cami Crouchet]

Glen is also my hero! Two other points I'd like clarification on -the Fed's refusal to recognize NSF as a separate category that all of us and consumers are quite familiar with and the Fed's placing of this entire burden on financial institutions rather than addressing the problem of those "gas station charges" that only validate $1.

[Anthony Demangone]

Cami, if I understand your question, the Fed doesn't think NSF is a proper way to describe a transaction that you pay. At the bottom of this issue, at least as it appears to me, is the fact that the Fed did not appear to understand how financial institutions process debit and ATM transactions. I hope that they are sifting through tons of negative feedback that they will have to address at some point in the future. Will they do an about face? I don' know. Stay tuned.

[William Blewett]

Anthony, What about the practice of charging an ODP fee on an electronic transfer but not covering the overdraft (member has opted out)?

[Anthony Demangone]

If you did not pay the item, then it would not an overdraft fee under the changes to Reg E. But remember - the member does not have to opt-out. You are only allowed to charge ODP fees under the rule if they affirmatively opt in.

[Jenny Colyer]

Does anyone know if there has been clarification on this yet? (wasn't there supposed to be more info. from the Fed in January?) We DO NOT offer courtesy pay and do not want to. But there is no way to word this sample OPT IN agreement to fit our CU.

[Anthony Demangone]

No updates yet, Jenny.

[Mary Jo Garofalo]

We don't want to wait until July to start trying to "convince" our members to opt-in. On the other hand we don't want to spend money for an opt-in mailing if there's any chance this ruling might be overturned. Is there any hope it will be overturned?

[Anthony Demangone]

Hi Mary Jo,

We haven't heard anything that would lead us to believe that the rule will be overturned. The Fed has indicated that it will issue some additional guidance, mostly likely to address the "gas station" situation outlined in this post. But I don't know when it will be issued, or what it will say.

- Anthony