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A well-managed, formal discretionary overdraft program—like a three-legged stool—should balance three key aspects: revenue, compliance, and service. The first two legs of the stool, revenue and compliance, are consistently discussed in the media and public discourse, while the third leg, service to both the consumer and the community, is often dismissed. However, failing to recognize the importance of this component leaves the overdraft program unbalanced, and your institution loses the opportunity to provide demonstrable account holder value.
It is true that the majority of financial institutions benefit from the income a formal discretionary overdraft program generates—$11.45 billion in 2017 for banks with assets over $1 billion, according to FDIC data.¹ Unfortunately, some media and consumer advocacy groups focus solely on the revenue leg of overdraft programs, branding them predatory and harmful to unwitting consumers, despite the fact that consumers continue to make the choice to participate in these programs because of the valuable service they provide.
What many derogatory articles, some lawmakers and even financial institutions fail to acknowledge, however, is the positive economic impact overdraft programs provide, not only to the consumers who need this source of liquidity, but to the economy at large. They also often misunderstand the characteristics of consumers who access overdraft services.
The Economic Impact of Overdraft
G. Michael Flores of consulting firm Bretton Woods, Inc., in 2017 conducted a study highlighting the purchasing power that overdraft programs provide. According to its analysis of 4.6 million consumer deposit accounts, users of overdraft protection realized an economic benefit of more than 7-to-1 when comparing funds extended to the fees charged for using the service.² Said another way: for every dollar consumers paid as an overdraft fee, they were able to purchase an item or pay a bill that was more than seven times the amount of the fee, equating to an annual stimulus to the economy of $65.6 billion.¹
But the purchasing power overdraft provides may be even greater, according to Velocity Solutions, a provider of revenue enhancement solutions for financial institutions nationwide. An analysis of data for 116 of the company’s clients (with a median asset size of $1.4B and using a dynamic overdraft limit program) shows that these institutions generated approximately $1 billion in overdraft fees on paid items in the amount of $21.2 billion for both personal and business accounts—providing purchasing power of approximately 21-to-1.³
In real terms, the economic impact these financial institutions provided through overdraft services meant that businesses were able to meet payroll obligations; individuals were able to make repairs on their homes; and local economies were bolstered. Without overdraft liquidity, in fact, each time a consumer is denied paying a bill or purchasing an item due to insufficient funds represents average lost purchasing power of $443 per occurrence, according to the Bretton Woods study.
The study also debunked the popular, yet erroneous, assumption that typical users of overdraft protection are poor. On the contrary, the Bretton Woods data revealed that middle-income consumers—who maintain higher monthly deposits—use overdraft protection services in a dynamic limit program more frequently than lower-income consumers with fewer monthly deposits. These consumers are also more likely to opt-in to Reg. E, which requires affirmative consent from account holders for financial institutions to charge an overdraft fee on ATM and one-time debit card transactions, further extending their purchasing capabilities.
Data Drives Economic Impact
Realizing the fact that a well-managed overdraft program can impart a positive economic impact to consumers and the community is one thing, but delivering this benefit is another. Overdraft software must harness transactional data—such as number and frequency of deposits, total paid items, debit card transactions denied due to insufficient funds, etc.—and your program provider must deliver analysis of that data and actionable strategies that optimize the program.
One such method of optimization is by setting overdraft limits that are in line with the consumer’s ability to repay the overdrawn balance and change those limits when ability to repay changes—a “dynamic limit” program. To do so, data-driven overdraft software analyzes key risk variables of your accounts, identifies those accounts with the highest probability of charge off, and calculates individual “intelligent” limits daily. Providing these dynamic limits helps serve account holders better than employing fixed overdraft limits (where the same overdraft limit is assigned to every account holder of a certain account type) by granting higher overdraft limits to those account holders whose ability to repay warrants it, yet lowering risk (both to the bank and the consumer) for those who cannot sustain the behavior. Using an ability to repay standard also has tremendous benefits from a compliance standpoint.
In terms of generating purchasing power, the Velocity Solutions customer data indicates that a fully-optimized overdraft program using ability-to-repay fundamentals has a purchasing power for consumer accounts of up to 8-to-1, compared to 5-to-1 for a fixed-limit program with a $750 limit. Assuming a $30 overdraft fee, these ratios translate into a relative purchasing power of $240 instead of $150 per transaction for each consumer account, and significantly higher if business accounts are included. A fixed-limit program also has a lower average paid item amount, as it can prevent a consumer from being able to complete larger single purchases.
In today’s healthy economy where consumer confidence is soaring, employment is high, and spending is on the rise, now more than ever is the time to employ an automated, data-driven and intelligent overdraft management system to ensure your account holders can access the full purchasing power the service provides while sustaining the account holder relationship and improving compliance.
² G. Michael Flores, “An Assessment of Usage of Overdraft Protection by American Consumers,” April 2017, https://www.aba.com/Advocacy/Documents/SmallDollarWhitePaper2017Apr.pdf.
³ Velocity Solutions, LLC NSF/OD data reflects a 365-day period, gathered for each financial institution between July 2018 to April 2019. The 116 clients are a subset of the financial institutions nationwide for which Velocity Solutions, LLC provides overdraft services.