Don’t underestimate regulatory scrutiny of overdraft programs

As regulatory attention to overdraft practices changes and intensifies, experts advise banks to dig deep in reassessing insufficient funds programs to improve and strengthen their processes and management.

By Christopher Delporte

The current bank overdraft policy environment is one of intense scrutiny, according to Jonathan Thessin, ABA’s VP and senior counsel, regulatory compliance and policy. Regulatory agencies are scrutinizing overdraft and nonsufficient funds fees and encouraging banks to reevaluate their overdraft programs, homing in on those banks where these fees comprise, according to regulators, a disproportionate amount of the banks’ fee revenue, experts say.

CFPB Director Rohit Chopra said earlier this year that his bureau will act against “large financial institutions whose overdraft practices violate the law” and will prioritize examination of banks that are “heavily reliant” on overdraft. Acting Comptroller of the Currency Michael Hsu took a similar though softer tone, cautioning banks: “You don’t want to be the last bank with a traditional overdraft system.”

During ABA’s recent Risk and Compliance Conference, Thessin, along with fellow panelist Aaron Rykowski, EVP, chief compliance officer of WesBanco, headquartered in Wheeling, West Virginia, described the scrutiny of specific overdraft practices and how banks should reassess their overdraft programs.

The most common practices targeted by regulatory bodies for lawsuits and enforcement actions are nonsufficient funds fees on re-presented transactions and overdraft fees resulting from “authorize positive, settle negative” transactions. With NSF fees, financial institutions may charge a nonsufficient funds fee on a transaction (such as a check) that is re-presented due to nonpayment the first time the transaction is initiated. The transaction is resubmitted by the merchant and presents again against a negative balance, for which the bank charges a second NSF fee.

With APSN, a first transaction is authorized on positive funds. In the meantime, a second transition posts to the customer’s account, which lowers the available balance. When the first transaction posts, it does so against negative funds and the customer incurs an overdraft fee.

Sufficient processes for nonsufficient fees

With NSF, agencies have said that they are examining banks for both deception and unfairness in banks’ practices. In spring 2022, the FDIC issued supervisory highlights that said charging multiple NSF fees when the same transaction is presented multiple times for payment against insufficient funds in a customer’s account could be “deceptive” or “unfair” under Section 5 of the Federal Trade Commission Act. To Thessin’s knowledge, the FDIC has cited banks for deception, not unfairness, related to this practice. Under a Financial Institution Letter issued in August 2022, the FDIC stated its expectation that banks will self-identify and correct violations. Examiners will generally not cite unfair or deceptive acts or practices violations that have been self-identified and fully corrected prior to the start of a consumer compliance examination. The FDIC also accepted a two-year “lookback period” for restitution in examinations. (Significantly, three days after this panel discussion, the FDIC revised its FIL to remove the lookback expectation unless there is a “likelihood of substantial consumer harm.”)

More recently, the CFPB and OCC entered into separate but related consent orders with a large bank in which the agencies stated that the bank’s practice of charging multiple NSF fees for represented transactions was an unfair practice—a finding that went beyond the FDIC’s focus on deception.

During the panel, Thessin recommended that banks review their account agreements to determine if they need to be strengthened to avoid a deception finding. To avoid an unfairness finding—which turns on whether the second NSF fee was “reasonably avoidable”—Thessin recommended banks provide multiple means for customers to check account balances and review the bank’s processes for advising customers of NSF fees.

“It’s in your interest to look at your processes for notifying customers of a low account balance, notifying of an NSF fee,” he said. “Most [banks]send letters, but also use text alerts and email.” Thessin continued: “If you’re scrutinized by regulators, you have all these ways to notify the customer that they’ve been assessed an NSF fee.” Thessin also stated that banks should “explain to examiners the significant logistical challenge of conducting a look-back.”

Regulators justify the potential unfairness finding by stating that the customer doesn’t know when a merchant is going to reprocess the transaction, Rykowski explained, but banks may not have that intel either.

“Banks don’t know either, right?” Rykowski said. “It could be a couple of days. It could be four days—or four weeks. We really don’t know when they’re going to send it back or how. The merchant could try to send it through as a paper check the first time and convert it to an ACH the second time. Logistically, we don’t necessarily know that’s the same transaction.”

APSN: All about disclosures

For APSN, the approach taken by regulatory agencies has evolved over the last few years. Going back to 2015-2016, regulators—the OCC, FDIC and CFPB—described the issues as one involving potential deception—that the agencies will cite a bank for deception if customers are not given proper disclosures of when they will be assessed an overdraft fee. In 2016, the Federal Reserve Board took a different approach and described it as matter of unfairness, in that the customer cannot “reasonably avoid” these overdraft fees. In 2022, the CFPB entered a consent agreement with a large bank and two weeks later issued a circular in which the agency took the position that these authorized positive, settle negative overdraft fees are unfair. The FDIC and OCC followed this spring, stating that APSN is an unfair practice, using language very similar to the CFPB.

“The clear takeaway is that regulators are pushing banks to bring on solutions so that you don’t charge the customer [an overdraft]fee under these fact patterns,” Thessin said, urging banks to look into current vendor solutions. “I will caution any of you who have tried to implement a solution: It’s a lengthy process. It takes more than weeks and months. And so, as you talk to your regulators, if you’re receiving scrutiny, emphasize that this is not a simple fix. I’ve talked to bankers who said, ‘It knocks out custom coding; it’s a multi-month—if not more than a yearlong—process to implement the solution.’ So that’s a real point to emphasize to your regulator. The takeaway from all four regulators is that banks need to be changing their practices now.”

Rykowski emphasized the continued importance of accurate disclosures. It’s important, Rykowski noted, that while there needs to be a modicum of personal responsibility on the part of the consumer, from a practical standpoint, looking at it from the banks and regulator perspective, it’s about disclosure. The FDIC, the Fed and OCC still focus more on disclosure and account agreements, and explaining to consumers how their account is going to function, he added.

“We’ve revamped our disclosures based on all the guidance over the past several years, so that we’re describing in detail in our account agreement how an APSN transaction could potentially occur,” he explained. “This is how you can be overdrawn. This is how we will assess a fee. And we did that in concert with our overdraft program disclosure. The CFPB doesn’t focus as much on disclosure; they just think the practice is inherently unfair because of that inability to avoid the fee.” But, Rykowski continued, “We know it’s completely avoidable through proper account management of different types of alerts and different types of account management tools. But disclosure really goes a long way.”

Being diligent about what disclosures say and making sure they line up with actual practices is “the biggest thing” to address from a risk-management perspective, Rykowski advised, adding that regulators are reviewing these issues based on current bulletins, circulars and advisory opinions. Rykowski noted that, in a few years, “if there’s a change in the White House, or a change in [an agency]director, by the stroke of a pen, these can all go away. So, from a disclosure perspective, do yours accurately describe what these transactions are going to do when they hit your customer’s account?”


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