How banks can tighten up their overdraft practices

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A pair of recent reports by the Consumer Financial Protection Bureau warns against banks abusing their overdraft practices beyond what’s lawful. Here’s how the CFPB is cracking down and what community banks can do to maintain overdraft oversight.

By Mary Thorson Wright

In the coming year, the Consumer Financial Protection Bureau (CFPB) will place a renewed emphasis on overdraft programs, fees charged and banks’ compliance with applicable rules. Other federal bank regulatory agencies are bound to pick up this issue, creating a renewed emphasis on community banks’ overdraft programs, particularly fees and the way banks impose them.

Why is this happening? Several lawsuits, examinations and regulatory enforcement actions regarding overdraft fees and practices have influenced a change in the CFPB’s appetite to pursue institutions that may be taking advantage of account holders with unseemly practices and violating federal regulations.

CFPB alleges exploitative conduct

Lawsuits, examination findings and enforcement actions for overdraft fees and procedures portray practices such as:

  • Charging overdraft fees by misclassifying nonrecurring debit card transactions as “recurring”
  • Charging unauthorized overdraft fees for account holders who say they never opted in or requested overdraft protection
  • Reordering transactions from largest to smallest, rather than chronologically, to lead to more overdrafts and fees
  • Switching to an available-balance method for the purposes of calculating whether a transaction results in an overdraft and/or whether the bank imposes an overdraft fee when a transaction is settled
  • Imposing overdraft fees each time a merchant attempts to process the same transaction
  • “Authorize Positive, Purportedly Settle Negative Transactions” (APPSN Transactions): immediately reducing a customer’s checking account balance when a debit card transaction was authorized on an account with sufficient funds to cover the transaction, then later assessing an overdraft fee on the same transaction if it purportedly subsequently settled into a negative balance

The CFPB has published two research reports on checking account overdraft fees, suggesting that banks, especially large ones, appear to be using what they deem exploitative junk fees rather than transparent, upfront pricing to generate overdraft fee revenue. While the reports focus on large institutions, regulatory practices and enforcement might well spread across the industry.

Based on those reports and the initiatives of the new director, Rohit Chopra, the CFPB will enhance its supervisory and enforcement scrutiny of banks that are heavily dependent on overdraft fees. As Chopra stated in his Dec. 2021 Overdraft Press Call, “We will be taking action to restore meaningful competition to this market.” He further committed to the CFPB acting against large financial institutions whose overdraft practices violate the law, seeking to uncover individuals who directed any illegal conduct. He noted that the CFPB is considering additional policy guidance to outline unlawful practices.

Overhauling overdraft protocols

What steps should community banks take to ensure prudent oversight of overdraft programs and identify potential regulatory issues in their overdraft practices? First and foremost, a bank must follow regulatory rules. In addition, its written procedures, account disclosures and actual practices should be consistent and accurate.

Several regulatory and industry standards govern overdraft programs, including Regulation Z—Truth in Lending; Regulation DD—Truth in Savings; Regulation E—Electronic Fund Transfers; and interagency guidance issued by the federal bank regulatory agencies, as well as guidance issued by agencies individually. Community banks must continue to follow the requirements to a T and retain a comprehensive process to meet each requirement.

Examiners look at written procedures, disclosures and evidence of actual practices. “Community banks are required to disclose fees and when the fees will be imposed,” says Rhonda R. Whitley, vice president and regulatory counsel at ICBA. “The prudent approach and best practice to preclude issues with regulators and consumers is to accurately, clearly and completely disclose overdraft program fees and how they will be imposed. Then, follow the established process without deviation.”

While the regulations dictate specific technical requirements, banks must also conform to the standards of the Unfair, Deceptive, or Abusive Acts or Practices Act (UDAAP). Any inaccurate information, omitted information or information that could be misinterpreted in printed or oral program descriptions, disclosures or advertising might be cited under UDAAP.

Considering expected regulatory scrutiny and potential rulemaking, what steps should community banks take? “Community banks should conduct an overhaul assessment of their overdraft programs, including disclosures, written procedures and practices,” advises Whitley. “Now is the time to ensure continued and consistent adherence to existing regulations and best practices. Doing so could help prevent customer confusion and mitigate negative examination scrutiny.”

How your CMS enables overdraft compliance

Whether conducted by the bank itself or a third party, solid Compliance Management System (CMS) oversight is key to conforming to overdraft guidelines. A bank should determine:

  • How are overdraft programs, including fees and how they are imposed, considered in the bank’s compliance risk assessment?
  • What coverage do overdraft practices receive in routine monitoring? In internal compliance reviews? In independent audits or third-party reviews?
  • Does the bank periodically compare the uniformity among regulatory rules, written procedures, account disclosures and actual practices?
  • What exceptions to policy occur for overdrafts or insufficient fund circumstances, how are they justified and how are they documented?
  • Are all critical aspects of the overdraft agreement with an account holder fully documented, such as disclosures of or response to the opt-in to effect “affirmative consent”?

Mary Thorson Wright is a writer in Washington, D.C.