By now, you are aware of the pending legislation and regulatory reforms to limit overdraft fees. If you’re not, I’ll assume you stumbled upon this blog looking for information about radon gas (psst … go back to Google and search again with one “d”).   

Long story short, as of July 1, 2010, the Federal Reserve will require consumers to opt in to overdraft protection for debit card and ATM transactions.  Financial institutions will no longer be able to charge overdraft fees on debit and ATM transactions without the consumer electing overdraft protection.  Instead of allowing a customer’s account balance to “go negative” with these transactions, the financial institution will be obligated to decline the transaction.  This is certain to lead to many unintended consequences for consumers and retailers, but the one unavoidable consequence – intended or not – will be a dried-up fee income stream.

Unless customers opt in.

Depending on most organization’s specific fee strategy and pricing structure, financial institutions stand to lose between 40 and 60 percent of annual NSF income. In addition to the Fed’s new rules, Senate and House bills may prohibit firms from posting items in any sequence that increases overdraft fees and may regulate the number and frequency of overdraft charges. Overall impact could be 20 basis points or more in Return on Assets (ROA).

The new rules will severely impair fee income for a great majority of financial institutions.  In a quick study of the RFG client base, we found:

• Ninety percent of RFG’s clients offer a courtesy pay program
• Almost half (45 percent) offer courtesy pay at the ATM
• Seventy percent offer courtesy pay on debit card transactions
• One quarter (23 percent) currently priority post items

We just finished hosting our regional client workshops in early December and courtesy pay was THE topic of discussion. Specifically, clients are most interested in discussing how to prepare for the new regulations.

The question facing our clients, and most financial institutions, is:

How do we limit the impact of the Fed’s new rules?  One option may be an opt-in strategy.

Should you consider an opt-in strategy?

Depending on your situation and your customer base, this strategy could involve a targeted and multi-channel initiative to encourage customers to opt in.  A recent FDIC study indicated that 93 percent of NSF activity is being driven by 14 percent of the accountholders. And an amazing 68 percent is being driven by just five percent of accounts. These consumers average $1,610 in NSF fees annually.

Doesn’t it make sense to try and protect this revenue stream and encourage these customers to opt-in? A few thoughts and questions: 

• Profile your active courtesy pay users so you can target for the opt-in process.
• What should the message be to encourage participation?
• Consider using electronic communication channels (online banking site, text message, email) to get the message out since there is a correlation with courtesy pay usage and younger consumers.
• Can you present an opt-in alternative through the ATM?
• Should you opt in customers during your new account process?
• What are the operational considerations?
• On and on and on …

 

Is a “wait and see” approach more appropriate?

Is it too early to begin opting in customers? If the final regulation includes an annual cap on the number of courtesy pay transactions via any channel, does it make financial sense to even try to opt in customers? Through our analysis of the FDIC study, we found that capping NSFs at six per year would decrease the average annual NSF income per account from $115 to $30. This will cost the average financial institution $850,000 annually per 10,000 checking accounts, assuming $27 per NSF occurrence.

 

Should you attack this issue with product design?

Many financial institutions are changing their checking menus.  Have any of you seen Probity’s checking account offer? It is interesting to note they recently increased their monthly checking fee from $19.95 to $29.95. It appears there is a segment that values unlimited overdrafts for a set monthly fee. The $360 annual fee income stream on this account is a far cry from the $1,610 generated by chronic courtesy pay users, but you should at least consider this type of account in your overall strategy.

Have you heard about the changes TCF is implementing? Instead of NSF fees, they will be charging daily fees for accounts that are less than -$5.

ING is now promoting Electric Orange Checking, an account without overdraft or monthly fees.

TD Bank has eliminated their free checking account. It is widely known within the retail financial services industry that the cost to maintain and offer a free checking product is subsidized by NSF fee income, but Congress seemed to overlook free checking as a consumer benefit in their effort to regulate bank fees.  Thanks to actions by our ill-informed political representatives working under the guise of consumer protection, free checking may disappear from the majority of banks’ checking menus.  Instead of a fee strategy based on NSF activity that affects a few consumers, banks may be forced to usher in an era of monthly maintenance fees or minimum balance fees that affects all consumers.  For most consumers, the cost of owning and keeping a checking account will increase.

The new courtesy pay regulations only apply to retail accounts. Does this change your appetite for small business checking accounts? If it does, what is your strategy to leverage your small business opportunities? Perhaps this is the motivation needed to identify existing small business customers using retail accounts, and to move them into small business accounts.

I recently had lunch with the EVP of a $10 billion Midwestern bank. At the conclusion of the lunch I asked him, “How can we help you next year?” He answered, “Help us identify the customer profile of those who are likely to opt in, and processes to efficiently get them to opt in.” His analysts have identified an eight-figure revenue stream at risk due to the courtesy pay regulations. That’s $10 million or more.  Annually.

The Answer: “To Opt In!”

Right now I’m favoring an aggressive opt-in strategy to protect as much revenue as possible. At a minimum, financial institutions should quantify the revenue at risk given current and pending legislation, and identify specific strategies that can be implemented to replace this revenue. You can bet the top three banks already have strategies in place to replace revenue they will be losing from changes to their overdraft programs.

RFG is conducting a study to help examine and benchmark the impact of proposed legislation on non-interest income for individual institutions.  You can learn more and sign up to participate in the Overdraft and NSF Benchmarking Analysis by clicking here.

Financial institutions should be discussing other impacts this legislation may have on their customers. A good example is the volume of returned deposited item checks from businesses. Prior to the new courtesy pay legislation, many of these checks would have been covered by their bank. Courtesy pay programs have afforded banks the ability to accept the risk of covering bad checks. Now banks may have no choice but to return these checks, impacting the cash flow of local retailers, and potentially forcing small businesses to allocate resources towards collections.

It’s unknown how the new rules may affect many routine purchases a consumer makes with the debit card.  Consider a transaction for gasoline.  Your bank may approve a $1 transaction when a customer initiates a gas purchase, but are you on the hook if the full amount overdraws the customer’s account?  Maybe a $75 or $100 hold will be required for gas purchases which could tie up more of your customer’s balance while creating confusion and a customer service headache.

Last week I had the opportunity to meet with more than 50 financial institutions at client workshops in Salt Lake City and Denver.  The consensus was for an aggressive opt-in strategy to try and protect this revenue stream. Should a cap of six NSFs per year become law, however, all bets will be off.  I may sound like Chicken Little to some, but because of this legislation, it is likely that free checking accounts will go away. Banks will begin rejecting more transactions and will be more inclined to close accounts because of chronic NSF activity.  This will lead some consumers to use currency exchanges for their basic financial needs. Ironically, the new regulations aimed at protecting this consumer segment may end up costing them more. We will be hurting the very consumers we are intending to protect. Supporters of the FAIR act may dismiss my comments as alarmist, but the potential for the unintended consequences of this act are very real.

What is your institution going to do? Please give us your comments – perhaps among our loyal Raddon Report readers we can generate a discussion that leads us to a better place by the time the proposed legislation becomes law.

Other posts on this topic include:

 

You’re going to lose fifteen basis points in ROA

Unintended Consequences: The FAIR Overdraft Coverage Act

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