FDIC Overdraft Guidance is Finalized

Posted by Anthony Demangone

You may recall that I wrote about an FDIC proposal earlier this year.  The proposed guidance would affect banks with overdraft protection (ODP) programs. Recently, the FDIC issued the ODP guidance in its final form.  This guidance does not apply to credit unions, so you may think that the issuance is not a big deal.  Let me be clear...

This is a very big deal. 

What the guidance does. The FDIC guidance "reaffirms" a best practices document that was issued in 2005, and it creates specific risk-mitigation techniques that it expects regulated banks to implement.  (Here's the 2005 best practices guidance, which NCUA and other regulators issued.)  Here are some specific risk-mitigation techniques:

• A bank's board must be involved with its ODP program. Regular oversight will be expected, including an annual board review of an ODP program's key features.
• Reviewing ODP advertising to minimize confusion and to promote responsible use.
• Monitor programs for excessive or chronic customer use.  What is abuse? When a customer overdraws the account on more than six occasions where a fee is charged in a rolling twelve-month period.  Ouch. When that happens, the bank must undertake "meaningful and effective" follow-up action, including, for example:
  • Contacting the customer to discuss less costly alternatives; and
  • Giving the customer a reasonable opportunity to decide whether to continue fee-based ODP coverage or choose another available alternative.
• Instituting appropriate daily limits on customer costs by, for example, limiting the number of transactions that will be subject to a fee or providing a dollar limit on the total fees that will be imposed per day.
• Considering the elimination of overdraft fees for transactions that overdraw an account by a small amount.
• Considering the use of cost effective, existing technology, as appropriate (e.g., text message, e-mail, telephone or cell phone) to alert customers when their account balance is at risk of generating a fee for nonsufficient funds.
• Reviewing check-clearing procedures and any third-party vendor to ensure they operate in a manner that avoids maximizing customer overdrafts and related fees through the clearing order. Examples of appropriate procedures include clearing items in the order received or by check number.

The FDIC expects affected institutions to have their new risk-mitigation techniques in place by July 1, 2011.

The effect of the guidance?  This guidance will create downward pressure on bank ODP revenue streams.  

What is this a big deal for credit unions?  Sure, this guidance doesn't apply to credit unions.  But guidance documents like this tend to find their way into other guidance documents or new regulations. Will NCUA follow suit?  Will the CFPB use the guidance as a blueprint for a new regulation that applies to all financial institutions? Only time will tell. But if I were a banker, my first thought would be this: Why does this only apply to FDIC-regulated banks? 

The bottom line is this: If your credit union earns income from an ODP program, that income is now at risk.  It is difficult to say how much, but you may want to consider the following.

• How much ODP income do you receive from transactions smaller than $10?  Or $5?  Should a small dollar amount transaction cutoff for fees take effect, ODP fees from those transactions could go away.
• How much ODP income do you earn from consumers who are charged more than 6 ODP fees in any 12-month rolling period?  If this applied to you, you'd have to reach out to them and show them alternatives. Let's say only 10% of those consumers opted out of your ODP program. How much money would that be?
• Do you clear items from largest to smallest in terms of dollar amount?  If you had to clear items based on the order received or by check number, how might that affect your income? 
• Imagine you implemented a daily limit of $25 or $50 for ODP programs.  How would that have affected your income in 2010?

Again, let's be clear.  The FDIC guidance does not apply to credit unions.  But as I have discussed, this guidance creates a nice road map for NCUA or the CFPB.  Any ODP income you have is now at risk.