One early Saturday morning when I was a small boy, my mother dispatched me to "ride your bike as fast as you can and make a deposit." Poor Mom had been up all night worrying, because she found an error in her checkbook. My mom and everyone her age was taught to avoid bouncing a check or you'd have to pay an overdraft fee-a penalty for bad checking behavior.
Today overdrafts (OD) are big business and tens of millions of users view ODs as both another checking operating cost and a safety net to help manage their financial affairs. To date in 2012 overdraft revenue at financials is more than $30.1 billion. Today's OD user wants their overdrafts paid more than ever, and does not like the prices being charged, the low limits offered, or the lack of timely, clear information. Today's user wants and needs a safety net.
Overdrafts are part of the Small Cash Market that includes frequent OD users, payday loans, funds from family and friends, check cashing and money orders at convenience stores, and much more. In total the Small Cash Market includes approximately 70-million Americans and billions of transactions.
The Federal Reserve's Reg E Opt-In change of August 15, 2010 requiring financial institutions to allow consumers to "opt in" for ODs on debit card and ATM, was an historic event changing overdrafts forever. It came just seven years after the Check 21 Act in which Congress instructed the Fed to eliminate float on check processing. Float averaged more than $10 billion a day in 2003 and has fallen to just 4% of this today. Adding to these transactions in transition, debit card usage was less than 20% of all transactions in 2003 and is now more than 50%.
Consumers In A 'Spin Dizzy'
The decrease in float and the increase in debit card usage have consumers in a "spin dizzy." Many are trying to manage their checking account balances without the cushion float provided and the instantaneous delivery debit card transactions do provide. Overall, checking transactions have doubled from about 20-25 a month per user in 2003 to almost 50 today. Mom, if she were alive, would be bewildered and I would be making multiple deposits for her to avoid an OD from happening.
Unfortunately, about three-dozen mega banks agreed to take the advice of a greedy consulting firm to consolidate batch transactions and rank from high to low the dollar value of potential OD transactions to extract greater revenue. All this has been happening as float was substantially declining and debit cards going into the transaction volume stratosphere.
Mega-banks needed to raise overdraft revenue to cover very costly checking accounts. Costs for mega-banks to service checking accounts are much higher than Main Street credit unions and community banks, because mega-banks are substantially beyond their economies of scale or cost effectiveness.
The Fed's Reg E Opt-in for debit card overdrafts was historic because the consumer finally had a chance to sign up for debit card overdraft service, most notably the 19-million people who use payday loans and the approximately 15-million frequent overdraft users at depositories. Tens of millions of overdraft users said they want the OD safety net, lower prices, better limits, and more information.
The Consumer Financial Protection Bureau created in the Dodd Frank Act has taken over the Fed's consumer regulation responsibility. Overdraft regulations are pending later this year or very early 2013 for implementation likely at the start of 2014.
What Can A Credit Union Do?
Most important is to move away as fast as possible from treating overdrafts as a penalty and treat overdrafts as a safety net. The chart shown here differentiates the two approaches:
The average OD price is $27.94 as Moebs $ervices' recent statistical survey of 2,700 credit unions and banks shows. This price is not competitive. The 19-million frequent OD users can go to payday lenders for their financial safety net-more often than credit unions or banks (with 15-million overdrafters). Why? The median overdrawn balance is $40 per Moebs $ervices analysis. Payday lenders would charge a median $17.50 per $100 advance to cover the $40. This is about $10 or 37% lower than a depository OD fee. Safety net pricing by depositories needs to be priced more competitively to give the user what they need.
Penalty pricing risk is high because little information is used to quantify the loss or risk. safety net pricing uses FICO scores and controls the front-end qualification and the back-end collections.
Moreover, FICO scores can determine limits. Those with higher FICO scores can get higher limits while those with lower FICO scores can get served instead of excluded. Risk-adjusting the limits leads to better control of the risk of loss and spreads the safety net of overdrafts to more users.
Transparency is speed of information and clarity of message. Penalty pricing doesn't fit well with transparency since the provider views the OD user as wrong for overdrawing. A safety net provider wants to assist the user with text messaging and emails while excluding legalese from agreements defining overdraft usage. The safety net provider gains more revenue the faster they inform and the clearer their message.
Finally, the safety net provider wants greater efficiency or lower cost because this lowers the price of the OD providing what the user needs-a low priced safety net. This OD safety net provider gets greater volume and more revenue.
My mother never had an overdraft. If credit unions and banks had offered a safety net approach with her checking, I bet she would have chosen to opt-in, not worried, and gone to bed.
G. Michael Moebs is CEO of Moebs $ervices, Lake Bluff, Ill. For info: www.moebs.com.