Why Community Banks Need to Offer Dynamic Overdraft Limits


There are many proverbs about the consequences of “standing still” and how the concept connotes inertia, or the lack of progress or growth. One well-known example is attributed to author Timothy Ferriss: “Many a false step was made by standing still.” While the concept is applicable to many things like major life decisions, risk-taking and business models, it also can be accurately attributed to overdraft limits. Are your limits standing still? In other words, are you offering only static, one-size-fits-all limits? If so, chances are that your overdraft revenue is likewise static.

American consumers differ dramatically in their income levels, deposit behavior, transactional activity and ability to repay. So why would you offer the same limit to all your customers?

Did You Know?
You don’t have to be a megabank to offer an overdraft program with customizable, dynamic limits that calculate ability to repay at an individual account level with sophisticated financial models.

Why offer dynamic limits? Here are the top 3 reasons you should:

  1. Provide a higher level of service to customers
  2. Meet compliance demands now – and in the future
  3. Drive incremental overdraft revenue

First, let’s define the difference between static and dynamic limits.

Both types of limit-setting strategies enable your bank to automatically allow or disallow overdrafts for those customers who utilize your service.

Fixed limits provide a “one-size-fits-all” approach that is determined at account opening. All customers who qualify to be in the program will receive the same overdraft limit; OR the limit varies based on account type (e.g., $500 for Free Checking and $750 for Premier Checking).

Dynamic limits are calculated automatically based on myriad customer data points, including specific deposit and overdraft activity. This data enables your bank to establish a risk profile for each account and assign individualized overdraft limits based on the customer’s ability to repay the overdraft and fees at any given time.

Both types of limits have been in use for many years, although community-sized banks utilize fixed overdraft limits more widely due to the previously high cost of developing or purchasing dynamic limit-setting systems.

However, times have changed and so must banks. Dynamic overdraft limits—the hallmark of a modern, automated discretionary overdraft program—are now affordable to implement and can help banks provide a higher level of service, meet compliance demands and drive incremental income better than fixed overdraft limits can.

Now, we’ll explain the top three reasons why your bank should be offering dynamic limits, regardless of your size.

Reason #1: You’ll Provide a Higher Level of Service to Your Customers
Although fixed limits may sufficiently serve some customers, they can be a disservice to many others, including 1) those who overdraw their account more than the fixed overdraft limit and have the ability to repay their overdrafts; and 2) those whose economic circumstances prevent them from being able to repay the overdrawn balance.

Data shows that, in the first group, the majority of these consumers typically can afford to repay the overdrafts and fees. They are living a convenience-driven lifestyle and they rely on the service to help them when their funds fall short.

Setting a fixed overdraft limit for these customers that’s too low subjects them to potentially more denied transactions or returned items—resulting in greater dissatisfaction, especially since they have demonstrated their ability to repay the bank.

Conversely, allowing the second group of consumers to overdraft within the fixed limit while their transactional behavior suggests they do not have the ability to repay is also a disservice, but one that can have devastating consequences for the affected by leading to charge offs and an inability to open an account later at another bank.

With dynamic limits, your bank provides customers a personalized overdraft service—one that pays more items for those customers who appreciate and can afford the service, while pulling back on overdraft limits for those customers whose ability to repay has diminished. Not only does this translate into better service to your customers, it also manages risk by assigning limits based on a customer’s ability to repay.

Reason #2: You’ll Meet Compliance Demands Now and in the Future
Federal regulatory guidance requires that banks monitor the credit risk of each customer.

In the Federal Financial Institutions Examination Council (FFIEC) Joint Guidance on Overdraft Protection Programs, the FFIEC wrote: “Banks also should monitor these accounts on an ongoing basis and be able to identify consumers who may represent an undue credit risk to the bank. Overdraft protection programs should be administered and adjusted, as needed, to ensure that credit risk remains in line with expectations. This may include, where appropriate, disqualification of a consumer from future overdraft protection. Reports sufficient to enable management to identify, measure, and manage overdraft volume, profitability, and credit performance should be provided to management on a regular basis.”

This ongoing monitoring requires banks to utilize advanced algorithms that analyze customer data on a daily basis and alert you to take action such as adjusting overdraft limits, suspending the service, suggesting counseling, etc.

Outdated overdraft systems with fixed limits simply cannot provide this level of sophistication. However, without it, your bank is at risk for higher charge-offs and at a loss when justifying overdraft limits to regulators.

Reason #3: Dynamic Limits Lead to Dynamic Revenue (i.e. You’ll Drive Incremental Overdraft Revenue)
Using fixed limits, your bank does not have the ability to increase a customer’s limit when that person’s capacity to repay increases. As a result, your bank foregoes income while your customer suffers.

Is your bank aware of the number of debit/ATM transactions denied for reason of non-sufficient funds (NSF)? A large percentage of these denials may happen to your customers who have opted in to your overdraft service for one-time debit and ATM transactions under Reg. E. These customers have proactively requested that you allow them to overdraft at these channels and they are willing to pay you a fee, but their transactions are being denied. Not only does this present a service dilemma, but it represents a missed opportunity for additional income.

Dynamic overdraft limits allow your bank to generate additional revenue by honoring more overdrafts, including Reg. E transactions, and helping more customers meet their short-term funding needs.

In deciding whether to implement fixed or dynamic limits, it is important to remember that both types of limits act only as guidelines for your customers and your bank. You have the discretion to honor or dishonor any overdraft, regardless of the customer’s limit, based on the individual’s circumstances and your own risk tolerance. Your overdraft program disclosures should clearly state that there is no guarantee of payment regardless of which type of limit you use.

If your bank encounters customers who want such a guarantee, it may be best to educate them on other overdraft options, such as a line of credit or a deposit transfer.

Remember, if your overdraft limits are static, your overdraft revenue probably is, too.