Beginning July 1, banks, credit unions, and other financial institutions will be prohibited from charging overdraft fees for ATM and one-time debit card transactions under new Federal Reserve rules. Presently, many banks automatically provide such coverage for fees of up to $35 or more. According to a Federal Deposit Insurance Corp. study, nearly 75 percent of banks sign up customers automatically for the service. Under the Federal Reserve's new rule, financial institutions must ask consumers whether they want to opt in for overdraft programs. Moreover, banks could charge only one overdraft fee per month, or six annually, and fees would be more proportional to the costs.
Over the past few years, overdraft fees has become a major revenue source for many financial institutions amid consumer shift from paper notes to plastic. According to Bankrate.com, The national average for overdraft fees jumped from $27.04 in 2005, for each instance, to $28.95 in 2009. The new rule is being seen as a major setback for US banks. Despite aggressive marketing campaigns, very few customers are expected to opt into overdraft protection. A 2008 Federal Deposit Insurance Corp study found that these fees accounted for 6 percent of U.S. banks' operating revenue. Banks bring in from $25 billion and $38 billion a year when customers overdraw their accounts, according to Fed officials. Michael Moebs, an economist and chief executive of Lake Bluff, Illinois-based Moebs $ervices, said the new Fed policy will cost banks on average a minimum of $5 per checking account. For the U.S. banking system, he predicts a cost of about $600 million, or 2% of the estimated $38.5 billion in consumer overdraft revenue. Joe Gillen, the CEO at Pinnacle Financial Strategies in Houston, estimates that banks could lose 40 percent to 60 percent of revenue from checking accounts after the new rules take effect.
Among various US banks, Citigroup and Bank of America are expected to be hardest hit by this regulatory storm. Citibank (NYSE:
C) currently charges a $34 insufficient funds fee for each separate time you overdraw your checking account-capped at four times a day. Bank of America's (NYSE:
BAC) charge is $35 each time you overdraft. Already, Bank of America lost around $160 million in revenue during the fourth quarter as a result of partial modification of its overdraft program. Late last year, Bank of America, stopped charging fees for customers who overdraw accounts by less than $10 in one day. The bank also started applying overdraft fees to four transactions per day instead of 10.
The American Bankers Association says it has found that those who pay overdraft fees are glad the transaction was not rejected and that the payment was covered. The banking industry has argued that customers have many ways to keep track of the money they have in their accounts. More important, they say, they are providing customers a service they actually want. More importantly, most consumers want banks to pay their overdrafts so they can avoid the inconvenience, embarrassment and potential costs of having a payment or transaction rejected."
Few industry experts believe that overdraft restrictions will likely prompt banks to explore new revenue sources. Some banks may experiment by reducing deposit account interest rates or possibly higher fees for customers used to no-fee accounts. Others may do away with unprofitable deposit customers. Few creative banks may even try to repackage overdraft protection and sell to consumers as a new and different product. The banks may replace overdraft fees and instead offer the customers the required "opt-in" approval. They may also push short-term products similar to "payday" loans. Citibank has already taken the first step- it is taking away many of the "free" features of their free checking accounts. A couple of months back, the bank announced that anyone that did not have at least $1,500 in deposit at the bank would have to eventually pay a monthly fee or a per-check charge. How far these innovative products are able to compensate for revenue loss remains to be seen.
Disclosure: Author doesn't own any of the stocks discussed here.
