Will overdraft take a bad bounce? To avoid stringentfederal legislation, banks must reexamine...

[ILLUSTRATION OMITTED]

The evening news comes on and you see an engaging young soldier preparing for his fourth deployment to a war zone. He sits before the camera in uniform, with his wife and young children. He tells the viewer about his weekend in the countryside with his family before

The news report explains that customers are in the best position to know their balance, and that the bank cannot know about outstanding items, which appears to have been the case here. It is also notes that overdrafts are intended to encourage customers to keep track of their spending and balance.

Not reported is the fact that the bank likely waived most of the fees.

Mostly what the public hears is:

"A bank charged an American soldier beading back to a war zone over $1,000 in overdraft fees for $350 in transactions, mostly small-dollar items that the bank approved"

This is not a hypothetical example. In fact, it was an actual nightly news report recently broadcast in Washington, D.C. Yes, the Washington, D.C., where members of Congress reside and make laws about banks--and watch the nightly news.

Overdrafts and reputation risk

Overdraft fees are not new. Banks have traditionally paid overdrafts as an accommodation to reliable customers and charged a fee, a perfectly acceptable and explainable practice. Paying the overdraft means the customer avoids the consequences of a returned item. This means avoiding: fees charged by the payment recipient; the embarrassment and hassle associated with resolving the returned item; and even the potential of having negative reformation reported to a credit bureau.

Moreover, the fees are avoidable and consumers have choices.

But over $1,000 for $350 in transactions, mostly small-dollar transactions?

This is the kind of news story that delivers burdensome and unnecessary regulations that all banks will suffer under. It has happened before. The Truth in Saving Act is a good illustration of this tendency. Congress considered and reconsidered the Truth in Savings Act over the course of several years. However, there was little compulsion or momentum to pass it, because generally banks were doing a good job of disclosing fees in a clear and understandable manner.

What ultimately pushed the legislation through, though, was a popular practice of paying interest on deposits based on the "investable balance." The investable balance was the balance not subject to reserves and thus investable. However, the interest rate disclosed did not reflect this factor. A typical statement was, "Our bank pays 5% on the investable balance," without necessarily disclosing at the same time what percentage of the customer's balance was investable, which could vary depending on the type of the account. Where the percentage was disclosed, the consumer was obliged to make the calculation to determine the rate of return.

Congressional response to this practice was the Truth in Savings Act.

Similar outrage to a particular banking practice is causing Congress to consider legislation that would address perceived overdraft fee abuses. Specifically, Congresswoman Carolyn Maloney (D.N.Y.), chair of the Subcommittee on Consumer Affairs of the House Financial Services Committee, has introduced a bill that, among other points, would:

* Require an APR calculation for overdraft fees.

* Require disclosure at both proprietary and nonproprietary ATMs at the time of transaction that proceeding with the transaction may cause an overdraft and the amount of the fee.

* Require customers to "opt in" before the depository institution may pay any overdraft.

* Prohibit depository institutions from "manipulating the process of posting" items if such a practice causes overdrafts. Clearly, these provisions are not practical or workable, and it is possible a modified approach will be considered.

However, if the industry wants to avoid unworkable and burdensome regulations that dictate checking account prices and practices, bankers need to review current practices and perceptions of those practices to ensure that they are understood and fair.

Improving overdraft communications

Two key factors, both dealing with debit cards, have altered how and when over draft fees are imposed.

The first is the perception that debit card transactions will not be processed or approved if there are insufficient funds in the account. The second is the increased use of debit cards, particularly for small-dollar transactions. These factors, combined, have led to a greater likelihood of high overdraft fees relative to the amount of the transaction--a result that frustrates and often surprises affected customers and infuriates some legislators and consumer groups.

Thus, a place for banks to start in the current overdraft debate is better communication with bank customers about overdrafts caused by debit cards, and modifications to current practices to address extreme, even if rare, cases.

Regulation DD already requires initial disclosures to explain the "categories of transactions for which an overdraft fee may be imposed," including those created by ATM withdrawal or other electronic means. However, customers may overlook these account disclosures or not understand the practical effect of the message, that is, that debit card transactions may cause overdrafts. Thus, banks could use imagination and marketing techniques to educate consumers that a debit card may cause an overdraft and provide the information at a time and in a fashion that they are likely to read, understand, and absorb.

To help customers avoid multiple overdraft fees for small-dollar transactions, banks could use the same imagination and marketing techniques to inform their customers about options to avoid overdraft fees. Options include: setting up overdraft lines of credit or links from a checking account to a savings or credit card account; keeping extra funds as a cushion; arranging for the bank to send an alert when the balance falls below a certain level; and encouraging use of a prepaid card for small-dollar transactions. Again, the information should be provided when customers are likely to notice it and in a manner that they understand.

Some banks cap the number of overdraft fees imposed in a day, or over a particular period, to mitigate the impact of multiple overdraft fees. Others are investigating the feasibility of limiting the amount of the overdraft fee to the amount of the transaction. Many banks permit customers to opt out of having overdrafts paid. Several have systems that permit customers to opt out of debit card overdrafts only, without affecting overdrafts caused by other types of payment. Liberal fee waiver policies for multiple overdrafts will also help mitigate customer aggravation.

Check federal advisory

In any case, all depository institutions offering these programs, whether they "promote" overdraft programs or not, should carefully review and consider the banking agencies' guidance on overdrafts issued in February 2005 (http://www.federalreserve.gov/boarddocs/srletters/2005/sr0503.htm). While their focus was on promoted programs, the agencies made it clear that the guidance applies broadly to all overdraft policies.

The appropriate and most effective ways to approach overdraft policies will vary from bank to bank. A careful consideration of a bank's practices, however, will help it retain customers--and avoid the role of the "heartless bank" in the evening news.

In any case, if Congress, the regulators, and the public do not feel that their concerns have been addressed, the government-imposed solution will undoubtedly be burdensome, costly, and overbroad.

By Nessa Eileen Feddis, ABA senior federal regulatory counsel, nfeddis@aba.com