Saturday, July 20, 2024

March 2005 Legal Briefs

Banking Agencies’ Joint Guidance on Overdraft Protection

1.  Background
2.  Safety and Soundness
    a. Account-Approval Standards    
    b. Ongoing Monitoring
    c. Delinquencies and Charge-offs   
    d. Call Report Treatment
    e. Vendors    
3.  Legal Risks
    a. FTC Act/Advertising  
    b. TILA/Reg Z   
    c. Equal Credit  
    d. Truth in Savings    
    e. EFT Act
4.  Best Practices
    a. Marketing and Communications
    b. Program Features and Operation 

Banking Agencies’ Joint Guidance on Overdraft Protection

In February the FDIC, OCC, Federal Reserve and NCUA issued joint guidance on overdraft protection.  These new guidelines are not formal regulations, but set a standard that overdraft programs should follow closely.  The guidelines also refer to and interpret other laws that may apply.

In the past, examiners have reviewed a bank’s overdraft protection program in a general way.  Now, with the joint guidance available, it’s inevitable that examiners will use it like a checklist to evaluate the details of a bank’s overdraft program.  For this reason, I expect banks to receive more specific and detailed regulatory comments on their overdraft protection plans, but the guidance doesn’t say this will happen.  

Banks need to adopt a formal policy governing overdraft protection—just as a bank’s lending program is governed by written policy.  This policy should review issues such as underwriting standards, nondiscrimination, adequate supervision by the board, monitoring of customers who may be abusing the overdraft protection program, proper accounting treatment for overdraft balances, creation of loss reserves, and clear consumer disclosures.  

The agencies have three general areas of concern relating to overdraft protection, which are (1) safety and soundness, (2) legal risks, and (3) best practices.  I will review these after providing a brief overview.

1.  Background

Overdraft protection plans have been around for several years.  The regulatory agencies have always had an uneasy truce with this product.  In 2001 the OCC outlined some concerns in its Interpretive Letter No. 914. In 2002 the Federal Reserve sought comments on overdraft protection programs but decided not to issue any new policy at that time.   (The Fed has authority to amend Regulation Z to cover these programs, but so far has declined to do so.)

The agencies recognize that overdraft protection is potentially beneficial for consumers; yet they worry that consumers may be misled if disclosures are inadequate.  They have agonized somewhat over whether banks are actively encouraging consumers to overdraw accounts.  They also worry that poorer consumers are most likely to overuse or abuse overdraft protection–incurring fees (and debt) that may be inappropriate to their situation.

Beyond that, the regulators have some anxiety that there is little or no credit underwriting in connection with these programs, and that there may be inadequate monitoring of particular consumers’ performance under these plans.  Some banks have no standardized procedures for establishing loss reserves or charging off past-due balances.

Another cause of uneasiness (from the regulators’ standpoint) is that overdraft protection as a program seeks to avoid regulation (falling outside of the truth-in-lending requirements of Regulation Z) based on technical exceptions, rather than attempting to follow specific requirements of any regulation.  As a result, overdraft protection has been a loosely governed product, existing in a grey area.  

After analyzing these programs for a while, and receiving public comments, the regulators have decided not to restrict overdraft protection programs, but instead want to heighten regulatory scrutiny of them.  In the joint guidance, the agencies have enumerated a variety of legal issues and regulatory concerns that must be considered. The regulators expect a bank to conduct its overdraft protection program with clear and careful policies, and in compliance with appropriate standards as stated in the guidance.

2.  Safety and Soundness

The agencies emphasize that overdraft protection is an extension of credit, although such plans are designed to avoid Regulation Z.  In general a bank should treat an overdraft protection program with as much seriousness as any other credit program.  Under the “safety and soundness” heading, the regulators raise many technical issues that automatically flow from the reality that overdrafts are credit.

If overdraft protection does not involve an analysis of the creditworthiness of individual accounts, the program exposes a bank to more credit risk (delinquencies and losses) than either (1) overdraft lines of credit (which are approved based on credit quality) or (2) traditional systems for paying overdrafts (because overdrafts are less encouraged and therefore occur less often).

The guidance indicates that all overdrafts, whether paid informally under a traditional system or as part of overdraft protection, are subject to safety and soundness considerations.

The agencies state that banks offering overdraft protection should adopt written policies and procedures addressing the credit, operational and other risks associated with overdraft plans.  (A written policy should match what the bank actually intends to do.)

a.  Account-Approval Standards. Prudent risk management practices include the establishment of explicit “account eligibility standards” and “well-defined and properly documented dollar limit decision criteria.”  A particular bank might decide that every checking account open for more than thirty days will get a $200 overdraft limit—or more—regardless of average daily balance, volume of transactions, prior account history, or any other factors. It’s simple to take this approach, but is this a prudent policy, by itself?

Does the bank have a pre-defined list of circumstances that will disqualify an accountholder from receiving the general overdraft approval that applies to other similar accounts?  A list of “negatives” to be considered should reflect credit risk factors that the bank finds significant.   

For example, if a customer is habitually late in making his loan payments, is it prudent to give him overdraft protection?  If that customer already has overdraft protection, should the privilege be suspended when other debt to the bank begins to go sour?  

If a person’s regular cash flow is so bad that he can’t make his loan payment to the bank, does it help to let him bring his loan current by using overdraft protection?  Doesn’t this just “mask” or put off a credit problem, instead of addressing the total picture?

(Do the bank’s loan officers monitor and potentially adjust a customer’s overdraft protection limit when they review that borrower’s overall financial circumstances?  If operations personnel establish the customer’s overdraft protection limits, do they also consider the status of that customer’s loans?)

Typically, overdraft protection is granted without any application by the consumer, so the bank often has no opportunity to pull a credit report.  But if the bank has actually declined a consumer’s credit application in the last six months, shouldn’t the bank’s awareness of the person’s bad credit be a factor in determining whether to grant overdraft protection?   If a consumer has filed bankruptcy within a certain time period, should overdraft protection be barred on this basis?

What if a customer has an unpaid charge-off at the bank?  This may be a very sensible reason not to grant overdraft protection—even if the charge-off is old.

How should a bank deal with a customer who develops a pattern of continued overuse of overdraft protection?  From a risk standpoint, this is probably a clear signal that the bank needs to reduce the customer’s overdraft protection limit–or terminate the customer’s participation in the plan.   

What if the bank receives garnishments or levies on an account (indicating that there is someone whom the customer is either unable or unwilling to pay)?  Should the account be evaluated for possible termination of overdraft protection?  (After an account is garnished the customer tends not to make further deposits, to avoid additional amounts being seized from the account.  If the garnishment or levy reduces the account balance to zero, and then the checks that are being presented on the account are paid into overdraft, this helps the customer, but is it good for the bank?)

And what about dramatic changes in level of activity on an account?  If a customer has been making regular deposits but suddenly makes no more deposits (possibly indicating loss of a job, or illness), should the bank consider reducing or eliminating the account’s overdraft protection limit?

The other way around, regulators would prefer for the bank to establish criteria for deciding when to increase a consumer’s permitted overdraft limit, and by how much, either automatically (by the bank’s own process) or in response to a customer’s request.  Does the bank grant overdraft-limit increases on a case-by-case basis, not according to any guidelines?  Ideally, objective standards worked out in advance would allow all bank officers to apply the same criteria in making such decisions.

To protect against inadvertent overdrafts, certain customers may need higher overdraft limits.  In particular this may be true of retail businesses that deposit a lot of checks.  They rely on their deposits being good, yet they may be stung unexpectedly by the return of deposited items that might cause the business’ own checks to bounce if overdraft protection is not large enough.   Ideally a bank would evaluate a customer’s creditworthiness and overall banking relationships before approving any overdraft protection limit higher than the typical amount.  (Alternatively, a customer may need a traditional overdraft line of credit.)

It may be appropriate to establish different overdraft protection limits for different types of accounts.  For example, the individual who opens a Super N.O.W. account with a required initial deposit of $5,000 might deserve a higher automatic dollar amount of overdraft protection (and would use it much less often) than the person who opens a “totally free” checking account with no minimum balance required.  

Does the bank increase an overdraft protection limit only for customers who request it, without re-evaluating other similarly situated customers who might also qualify?  Does the bank suggest to some customers that they apply for a higher overdraft limit, without making the same suggestion to others who may be equally deserving?  The bank needs to be careful to avoid discrimination in how it provides overdraft protection—just as for general lending activity.

b. Ongoing Monitoring. 
Banks should not only monitor individual consumers’ use of overdraft protection accounts, but also report to the board concerning volume of overdrafts, profitability, and credit performance in the overall overdraft program.  A bank regularly reviews a particular loan product (such as car loans) for the appropriateness of interest rates and fees, amount of loan losses and collection costs being incurred, and level of delinquencies.  Similarly, a bank should review its overdraft protection program to see how it is working as a credit product, and whether adjustments are necessary in pricing and other features.

If, for example, a bank offers $400 of overdraft protection to most customers, the bank should observe whether customers are using this program in line with the bank’s expectations and desired level of credit risk.  (If it appears that only the weakest borrowers are using the maximum overdraft limit, and there’s a pattern of doing this as personal financial circumstances are deteriorating badly, the general overdraft limit may be too high.  Better monitoring of individual accounts may be desirable, so that the bank can decrease overdraft limits on accounts where “red flags” start appearing.)  

Over time, it may be appropriate to increase or decrease the general overdraft protection limit as experience gives the bank more information.  Only certain categories of checking accounts may need adjustment, or different rules may need to be applied to different accounts within the same category, based on financial criteria such as monthly deposit totals or average balance history.

c.  Delinquencies and Charge-offs.   A bank needs written procedures for dealing with consumers who are slow in paying their overdrafts—just like past-due loans are governed by written guidelines.   Most banks have a requirement that accounts be returned to a positive balance every 30 days (or a shorter time period), and failure to comply with such rules will result in automatic suspension of overdraft coverage, even though the consumer’s overdraft limit may not have been reached.

Most banks also have a series of two or three standard letters that they send to consumers who are late in clearing overdrafts.  (The first letter is gentle, and later letters are more insistent.)  These letters are sent at specific intervals, and are part of the bank’s “collection” process for delinquencies.

Regardless of the bank’s internal schedule and specific steps for dealing with past-due overdraft balances, the agencies’ joint guidance now imposes a requirement that the entire overdraft balance be charged off when it is considered “uncollectible,” but not later than 60 days after the date when the first of the overdrawn and still unpaid items was posted to the account.   (This same rule applies to overdrafts of any kind, including the traditional version where a bank pays overdrafts only at its discretion, with no pre-announced available overdraft limits.)

The regulators note that some banks offer an extended repayment plan if consumers cannot take care of their overdraft balance promptly.  (For example, after the customer gets into trouble, a bank might require the customer to pay at least one-sixth of the overdraft amount per month, for six months, until it is satisfied in full.)  

However, a customer’s agreement to comply with a deferred-repayment arrangement does not change the bank’s requirement to charge off the entire overdraft balance within 60 days after the posting of the first overdraft amount that remains unpaid. Instead, payments received after the 60-day cut-off must be handled as recoveries of already-charged-off balances.

Past-due overdraft balances (whether part of a formal overdraft protection plan or not) usually have more credit risk than ordinary loans.  This is why charging off such balances after 60 days is appropriate.  

With overdrafts there is no promissory note, and no collateral.  There also is no credit file (no credit report, no balance sheet, and no income information), unless the bank has made other loans to the same customer.   The bank only knows that the customer is not paying.  It doesn’t know about the customer’s ability or willingness to pay in future.  The bank must sue in small claims court on the basis of the customer’s deposit agreement, not any note.   Even after obtaining a judgment, the bank can’t be sure that it will be able to collect.

Some banks require a promissory note to be executed by a customer who fails to clear his overdraft balance in a timely manner.  However, taking a note for the overdraft balance, even when combined with the customer’s beginning performance under that note, will not be sufficient by itself to avoid the requirement that an unpaid overdraft balance be written off within 60 days.  To avoid writing off the overdraft balance that is converted to a promissory note, the bank must properly qualify the debtor for credit.  In other words, the note must be bankable, based on the customer’s credit quality, collateral (if any), and demonstrated ability to repay.  After a bankable note is booked, it will be treated like other consumer credit and does not have to be written off.   

Of course, proper TIL disclosures must be given in originating any note, and failure to require at least a market rate of interest on a note that represents unpaid overdrafts might cause it to be classified.

d.  Call Report Treatment. 
Income and losses on overdraft protection programs should follow generally accepted accounting principles and call report instructions.  The regulators state that overdraft balances (whether part of an overdraft plan or not) are to be reported on call reports as loans.  (In other words, a deposit account with a $200 negative balance is not netted against deposit account totals for other customers, reducing a bank’s total reported deposits.  Instead, accounts with positive balances are reported as deposits, while negative balances on accounts should be combined and reported as a category of loans outstanding.  

The agencies want banks to adopt rigorous loss-estimation processes for overdraft balances.  Just as with loans, banks should develop a good method of estimating how much loss they are likely to incur on the amount of overdraft balances (including posted fees) that they are carrying on their books at any time.  Banks should make appropriate provision (as part of their loan loss reserve) for future losses on overdraft balances.  As overdraft balances are actually written off, banks should charge those amounts against the reserve.

Alternatively, a bank may choose to report as current income less than 100% of the overdraft fees that it currently is posting (reducing total fee income by the amount of estimated future losses it will incur on the overdraft balances it is currently carrying).  The agencies are not saying that a bank can simply reduce its currently posted overdraft fee income by its current charge-offs on overdrafts.  (That method would over-report current income and under-report the risk of loss on overdraft balances currently being booked.)  Instead, the bank must currently estimate and make provision for all estimated future losses on overdraft balances that, for example, may not be written off until as much as 60 days from now.

An additional call report issue is the reporting of overdraft limits.  For example, a customer receives a letter telling him that he has a $300 overdraft limit, but he currently does not have any overdraft balance.  The agencies will require banks to report the person’s $300 limit on the call report as a “legally binding commitment,” even though the bank technically reserves the right not to pay overdraft items.   Available but unused amounts of overdraft limits should be reported as “unused commitments.”  Thus, a bank with 10,000 deposit accounts that have a $300 overdraft limit would have $3 million of “unused commitments” to report on its call report (less the portion of overdraft limits actually outstanding in the form of overdraft balances, which instead must be reported as loans).

For the purpose of risk-based capital requirements, commitments having a maturity of one year or less are assigned a zero percent weighting.  A zero percent conversion factor also applies if a commitment is unconditionally cancelable by the bank.  Since the bank’s disclosures typically state that the bank reserves the right to decline to pay any overdraft, reporting these “unused commitments” represented by overdraft limits should not result in any increased capital requirement.

e.  Vendors.  If a bank wants to arrange with a third-party vendor to set up an overdraft protection program, the bank should conduct a “thorough due diligence review” of that vendor before entering into any contract–just as the bank must do for other third-party vendors providing any type of technology services.  (Complex services that must be legally compliant involve more risk and require more diligence than buying office supplies, etc.)

3.  Legal Risks

The joint guidance outlines several Federal laws and regulations that may apply to overdraft protection programs.  Although entering into an arrangement with a third-party provider of overdraft protection programs may be expensive, it does provide reasonable assurance that complicated legal issues will be dealt with correctly in establishing and administering overdraft programs.  There are pitfalls for a bank in attempting to design its own version of overdraft protection.  It is absolutely critical that a bank avoid making certain statements, while being certain to disclose other matters clearly.  Overdraft protection is an area where the competing goals of effective marketing and legal compliance can be very much at odds with each other.

 If a bank wants to set up overdraft protection without using a third-party provider that has already considered relevant legal issues, the agencies warn that the bank’s attorney should review in advance all documents that the bank proposes to use in connection with such a program. (This includes the proposed form of letter to customers to announce the program, any brochure the bank will prepare, any advertising, and any letter that will be sent to customers at various points, including letters offering payment terms to those who do not clear their overdrafts promptly.)

I will briefly outline some concerns the regulators have raised under five specific Federal statutes.  (Other Federal or state regulations may apply.)

a. FTC Act/Advertising.  The Federal Trade Commission Act prohibits unfair or deceptive acts or practices.  An act or practice is unfair if it causes or is likely to cause substantial injury to consumers, who cannot reasonably avoid it, and the harm is not outweighed by related benefits.  An act or practice is deceptive if a consumer, acting reasonably, is likely to be misled by some significant representation, omission or practice.

Marketing and explanation of overdraft protection plans, if done wrong, can be deceptive.  (To avoid restrictions in Regulation Z, a bank must refrain from stating in writing (or strongly implying) that it absolutely will pay overdrafts.  A bank must clearly explain that it is not obligated to pay items—that it reserves the right, in its discretion, not to pay overdrafts. However, the bank’s marketing officer often feels this is a “muddled” message.  That person often wants to simplify the message and strengthen the impression that consumers can rely on the program to pay overdrafts.  This is the primary area where a bank’s disclosures can become deceptive.)

b. TILA/Reg Z.   The Truth in Lending Act and Regulation Z impose disclosure requirements with respect to consumer loans.  Overdrafts are “credit,” so to avoid TILA disclosures a transaction must specifically fit one of TILA’s exceptions.  If a bank pays overdrafts but has not promised to do so in advance, the payment of overdrafts does not require advance disclosures as outlined in TILA.  

If the bank states in writing that it will pay overdrafts (for example, in the letter announcing the program), disclosures will then be required.  Similarly, if the bank’s marketing brochure or ad suggests that the bank absolutely will pay overdrafts up to a certain dollar amount, TILA disclosures are required.  

After overdrafts have been paid—even with no advance promise to do so–if the customer does not clear overdrafts as quickly as required, and the bank offers a payment arrangement of more than four installments, TILA disclosures will be required at that point.  

c. Equal Credit.  The Equal Credit Opportunity Act and Regulation B apply to overdraft protection programs.  A bank cannot have a discriminatory purpose or discriminatory impact in approving some persons for overdraft protection but not others—but it can make distinctions based on credit quality, type of accounts, and other reasonable criteria.  If a bank doesn’t check credit before providing overdraft protection, it should be especially careful not to treat people differently.

The regulators caution that it’s wrong to target only certain groups for overdraft protection accounts (as this may amount to “steering”), while leaving those same groups uninformed about overdraft lines of credit, consumer loans and other overdraft services with more favorable terms that the bank offers to others.

d. Truth in Savings.  Overdraft protection is tied to a deposit account.  Therefore, a proper Regulation DD disclosure must include any fees that can be charged to a consumer’s account as a result of overdraft protection.  When overdraft protection is added to an existing account, there may be some increased or additional fee that’s adverse to the customer.  If so, the bank must give 30 days’ advance written notice before adverse changes in terms can take effect.  

However, if an existing account already discloses an NSF or overdraft fee, and the overdraft protection plan does not involve new fees or higher fees than those which already applied to the account before the overdraft protection plan was announced, there possibly is no adverse change for the customer, and on that basis 30 days’ notice of the change may not be required.  

Truth in Savings requires accurate disclosures not only at the time of opening or modifying an account, but also in advertisements, announcements or solicitations.  A misleading description of an overdraft protection account—such as in an announcement letter—could violate both the FTC Act (mentioned earlier) and the Truth in Savings Act.

e.  EFT Act. 
In the context of deposit accounts, the Electronic Funds Transfer Act and Regulation E apply to transactions that use ATM cards, debit cards, pre-authorized automatic debits (ACH), on-line bill pay, and electronic (on-line) transfers between accounts.  Some banks do not offer all of these transactions, and some accounts within the same bank involve more of these types of transactions than other accounts do.  

However, if a particular account has overdraft protection, the overdraft limit usually can be accessed not only by check but also by any other type of transaction permitted on the account.  (In other words, an ATM card can be used to overdraw the account; a merchant transaction using a debit card can access the overdraft limit; and a pre-authorized ACH for the monthly insurance payment or utility bill can access the overdraft limit.  It also may be possible to make an on-line transfer between accounts or an on-line bill payment that will actually dip into the overdraft protection limit.)

Where overdraft protection involves an electronic funds transfer, the
EFT Act and Regulation E do apply.  Of course, monthly statements are always required when electronic transactions occur (if the deposit account would not otherwise receive a statement in that particular month).  

Beyond that, because electronic transfers are involved, periodic statements must be readily understandable and accurate regarding debits made, current balances, and fees charged.  (See below for more on stating “current balances” clearly).   ATM receipts must be readily understandable and accurate regarding the amount of the transfer.

4.  Best Practices

Here’s where the provisions in the joint guidance get tougher.  Many points in the “best practices” section of the guidance are strongly suggested, while others are legally required.  All of these “best practices” are characteristics that regulators definitely are looking at.  Banks are placed on notice that they can be criticized for operating outside of best procedures, if these matters are routinely ignored—even though there might not be a specific statute on some points.

(The OCC, for example, often cites a bank for “reputation risk” when it does something that the OCC dislikes, outside the bounds of what seems fair.  Or the OCC can cite a bank for “litigation risk” when something may be sufficiently inflammatory that a consumer might want to sue the bank because of it—rightly or wrongly.)

As an introduction to the “best practices” list, the agencies restate that consumers must receive clear disclosures and explanations about the operation, costs and limitations of an overdraft protection program.  Also, management must provide appropriate oversight for the program.  These two themes are more specifically laid out in a list of “bullet points” that I will review here.

a. Marketing and Communications. 
There are ten subpoints under this topic:

(1) Not promoting poor account management.  Banks should emphasize the program as a service that may cover unintentional overdrafts.  Banks should not market the program to encourage routine or deliberate overdrafts.  (Thus, don’t say, “Need extra cash until pay day?  We’ve got you covered with overdraft protection.”)

(2) Informing consumers of alternative products.  Instead of just informing consumers about an overdraft protection program, the bank should also inform them about other available products, including an overdraft line of credit (if available), or consumer loans.  Ideally the specific terms, including fees, for these other available services should be explained so that consumers can make a clear choice.  (Just as banks often prepare a brochure listing their deposit accounts side by side, with a clear statement of fees and limitations that apply to each, it might be appropriate to put (1) “overdraft protection,” (2) an “overdraft line of credit” and (3) sweep accounts, all in the same brochure, to allow easier comparison.)  Consumers need to be cautioned about the consequences of using overdraft protection too much.

(3)  Training staff to explain overdraft protection and other choices.  New accounts officers and customer service personnel should be trained to explain the features, cost and terms of an overdraft protection program, including how to opt out of the service. They should also be ready to explain other types of overdraft products that are available (such as an overdraft line of credit, or an automatic sweep from savings to checking when the account balance is not large enough to pay items being presented) and what the consumer must do to qualify for these other choices.

(4) Explaining clearly that paying overdrafts is in the bank’s discretion.  To fall outside of Reg Z’s disclosure requirements for consumer credit generally, the bank must retain the right not to pay overdrafts as they are presented. Because this is the “exemption” that a bank will be relying on, the consumer must understand very clearly that the bank reserves the right to decline to pay any overdraft.  This cannot be minimized for marketing purposes by implying that payment of overdrafts is guaranteed or assured.

Some people apparently believe it is possible to avoid the Reg Z restrictions by not promising in writing to pay overdrafts, while making that promise verbally to customers who inquire.  The problem with this “doubletalk” approach, as I see it, is that both the FTC Act and EFT Act also apply, prohibiting deceptive or misleading disclosures.  I would not advise any bank to say one thing in writing, while stating verbally, “We have to say that, but don’t worry about it.”  A bank should get all of its employees on the right message, and stay on that message.

(5) Not promoting overdraft protection and “free” accounts together.  Banks should not advertise accounts as “free,” while also mentioning overdraft protection in the same advertisement, if someone could be misled into believing that overdraft protection is free.  (Ideally, overdraft protection would be mentioned as an add-on feature that is available, not required, and something that does involve fees.)

(6)  Clearly disclosing overdraft protection fees.  In communicating about overdraft protection, a bank should clearly disclose the dollar amount of any overdraft fee, and the amount of any other fees that may apply, as well as the amount of any interest.   A bank cannot avoid disclosing its fees for overdraft protection by just stating that the bank’s “standard overdraft fees will apply,” because this fails to disclose the dollar amount.

(7)  Fees counted against the overdraft limit.  Many customers, when told that they have a $200 overdraft limit, will assume that they can write overdrafts totaling $200.  In reality, banks include the overdraft fees that are posted to the account as part of the overdraft limit.  This needs to be clearly explained to the consumer so that he will not be confused.

(8)  Fees are per item, not per day.  Some consumers think an overdraft fee is charged when an account becomes overdrawn—a single event, or something that may happen a day at a time, not tied to the number of items presented.  In other words, they may think that the overdraft fee is for the privilege of overdrawing, not for the number of overdrafts presented per day.  It must be clear that multiple overdraft charges will be posted to the account on the same day if multiple transactions dip into the overdraft limit (or are returned).  

(9)  Order of paying transactions.  Customers should clearly understand that checks and other transactions will probably not clear the bank in numerical order.  The bank is not obligated to minimize overdraft fees by re-arranging its standard order for paying items—for example, its policy of paying in “large to small” order.

(10)  Explaining what transactions can incur a fee.  If the brochure or ad for an overdraft protection program only mentions checks, some consumers may assume incorrectly that an overdraft fee applies only to insufficient checks. It’s more likely that any type of debit accessing the overdraft limit will result in an overdraft fee, and the customer should understand this.  If accurate, a bank should explain that any posted transaction (ATM, debit card, ACH, online transfer, check, in-person withdrawal, etc.) could incur an overdraft fee.  

b. Program Features and Operation. 
The regulators list seven subtopics under this heading:

(1) Opt-in or opt-out.  Banks either (a) should provide overdraft protection only if customers request it, or else (b) may provide it automatically, but should give customers a clear way to opt out of it—probably mentioned in the same letter that announces the plan, as well as in brochures.  (Either way, the customer understands that it is voluntary.)  You may say, “What harm could there be to consumers in granting credit that was not requested?”  But some consumers are on a “pay-off-the-debt” program, or feel tempted by credit that’s too easy, and would actually prefer not to have this credit feature so readily accessible.  Banks should respect this.

(2) Warning before a fee is imposed.  Where feasible, best practice is to warn a customer that a withdrawal or transfer will cause an overdraft fee to be imposed.  If a person walks up to the teller window and wants to withdraw $50 (perhaps not realizing that this will overdraw the account), the teller who checks the available balance should advise the customer that an overdraft fee will apply.  (There is no technological reason why the teller cannot do this.)

If overdrafts can occur through an ATM, the ATM screen ideally would warn the customer that an overdraft fee is about to be charged, giving the person an opportunity to cancel the transaction.  (This is similar to an on-screen or posted notice at the bank’s own ATM, warning non-customers that a fee will apply for using that ATM.  The consumer then has an option to cancel the transaction and avoid the fee.)  If on-screen notice is not feasible, banks should give notice by posting a sticker on their owned ATM’s, stating that transactions may be approved that overdraw the account, resulting in an overdraft fee.   

The regulators suggest that banks consider making overdraft protection available only by check (for example, not allowing overdrafts by ATM).  This will depend on the individual bank. I personally think that overdrafts by ACH and debit card transactions need to be allowed, to cover checkbook math errors or unexpected returns of deposited items.  And if someone has a family emergency, I’m not sure that it helps the customer to have no ATM access to his overdraft limit.  

(3) Distinguishing deposit balance from overdraft limit.  When only one account balance is disclosed by any means (an on-line available balance, or an ATM-machine account balance), the available balance should not include the overdraft protection limit.  It’s sometimes O.K. to disclose two separate balances—the consumer’s own deposit balance, more prominently shown, and also a larger balance that is clearly labeled as including the overdraft limit.  

(4) Notifying consumer of overdraft protection usage.  Best practice is to send the consumer a prompt notice on each day that the overdraft protection has been accessed, stating the date, the amount and type of items that were paid into overdraft, the fee(s) imposed, the resulting negative balance (what’s required to return the account to a positive balance), the amount of time allowed to clear the negative balance, and the consequences of not doing so.  If the overdraft limit will be terminated or suspended if the customer becomes no longer in good standing, the notice should say so.  

(The regulators are looking for an overdraft notice like a bank typically sends when it pays overdrafts case-by-case at its discretion, but with some additional information added.  The agencies do not want these accounts handled like credit cards, where transactions continue to be posted as long as they fall within the credit limit, and only a monthly statement is sent.)

(5)  Considering daily limits on overdraft charges.  The regulators would like banks to consider either a numerical limit or a dollar limit on the total overdraft fees that can be posted to an account in one day.  This would certainly help to limit consumer unhappiness in situations that are accidental (such as returned deposit items or math errors), but it’s only a suggestion.

(6) Monitoring how consumers use overdraft protection.  Banks should monitor excessive usage of overdraft protection by individual consumers, because this may indicate a need for alternative credit products.  Banks should inform such consumers of the availability of these other options.

(7)  Fair credit reporting.  If consumers incur overdrafts and pay them in compliance with the allowed terms of an overdraft protection program that the bank has promoted, the bank should not report negative credit information on those consumers to the credit bureau or check-approval companies.