OVERDRAFT PRIVILEGE: SERVICE OR BURDEN?
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 check overdraft programs. 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, overdraft 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 account holders or members of financial institutions - checks that would otherwise bounce due to non-sufficient funds (NSF). This privilege often extends to customers' ATM 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 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. Most bankers offering overdraft see the programs as an absolute win-win situation for merchants, institutions, and their customers. An Indiana community banker, for whom my firm assisted with a program three years ago, makes a good case for accountholders acceptance of the program:
"Our customers have been very pleased with our (Overdraft) program. In fact, we occasionally get thank you notes from them. They really appreciate the fact that their (NSF) check doesn't 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 don't pay a hefty fee to that retailer."
Ironically, it is typically not low-income account holders who use overdraft, but rather moderate-income earners, who tend to live from paycheck to paycheck. Customers with Overdraft 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 fall short at the end of the month. 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 overdraft programs 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 ODP's benefits."
One Kentucky banker conceded that charge-offs for bad accounts had increased, but were acceptable in relation to the new income from the service), and that account turnover had actually slowed because the service had solidified the bank's relationship with its customers.

Questionable ODP Practices Demand Industry and Fed 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 overdraft limit in the customer's 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 overdraft 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. While there may have to be some distinct categories of exclusion such as dormant accounts, minor accounts and savings or money market accounts - there should be no wholesale "redlining."
Our firm's Overdraft Privilege programs - implemented by about 400 institutions in the past 15 years -- meet all Federal Reserve System requirements and even suggested changes. Adoption of well-managed programs universally will bolster bottom lines in the banking industry and benefit a wide range of consumers, as well as merchants.

Conclusion
The advantages and shortcomings of some overdraft programs warrant national discussion and better consumer education. Financial executives need to proceed cautiously. Customers need to use overdraft wisely, not habitually. Steps must be taken to prevent practices that might keep an otherwise beneficial and legitimate service from maximizing its value to all affected.

John M. Floyd is CEO of John M. Floyd & Associates of Houston, a profitability consulting firm to more than 1,400 financial institutions in the past 26 years and a recognized leader for its Overdraft Privilege programs. He welcomes comments or contact at 800-809-2307 or by e-mail through the Web site, www.overdraftprivilege.com

Filed April 2003