Bounce Protection: The Agencies Weigh In

Since its introduction several years ago, the regulatory agencies have expressed serious concerns about bounce protection programs which, unlike traditional overdraft programs, can lead consumers into an overdraft situation and the related costs without the consumers' advance knowledge. While the agencies have not actually stood on the front step and labeled such programs as unfair or deceptive, they have issued numerous warnings. The latest pronouncement has been made official.

In June 2004, the members of the FFIEC proposed Interagency Guidance on overdraft protection programs. Together, the agencies received more than 320 comment letters from both industry and other interested parties. The comments raised some predictable points, both opposed to and in support of aspects of the proposed guidance.

Comment issues included extending the length of the charge-off period from 30 days to as much as 60 days, clarifying that the guidelines would not apply to other overdraft programs (watch out - they do!) and asking that the guidelines support the position that the overdraft protection programs are not credit subject to Truth in Lending.

Consumer comments often took opposite positions, asking that the programs be made subject to Truth in Lending because it is comparable to payday lending and raising concerns under ECOA as well as predatory practices.

The final guidance is instructive, not only for its content, but for the implicit warnings that it contains. Financial institutions would be wise to heed these warnings. In addition, the final guidance warns savings associations to comply with all applicable federal laws and regulations and to have their program reviewed by legal counsel prior to implementation of the program.

OTS has issued a policy separately from the other FFIEC members. The differences are slight and subtle, but revealing. Most of the differences were based on wording to place different emphasis on similar rules. However, the OTS omitted the entire section on legal issues (summaries of related regulations) which was included in the FFIEC document. All of the agencies recommend applying the principles of the policy statement to all overdraft programs, including the more traditional pre-approved lines of overdraft credit. They have worded this advice with slight differences.

Concerns
The agencies identified a number of concerns related to overdraft protection programs. These include promoting the service in a way that leads consumers to think that the service is a line of credit without clearly disclosing terms and conditions. Other concerns are marketing practices that encourage consumers to overdraw their accounts or induce consumers to ignore account balances and rely on the overdraft protection.

The agencies are also concerned that institutions offering overdraft protection are taking on risk without analysis of the consumer's creditworthiness. In offering and administering the programs, institutions are urged to carefully weigh the risks of the programs, including the creditworthiness of consumers.

The agencies place slightly different emphasis on the approach to underwriting but all agree that the program is credit for purposes of safety and soundness. The "majority" document makes several clear and pointed references to safety and soundness. In fact, the document overtly states: "When overdrafts are paid, credit is extended."

Another concern is the imposition of fees for overdrafts without providing the consumer with any notice about the fee or any opportunity to avoid the fee. Here again the agencies vary slightly on the best approach with OTS taking the strictest position.

Safety and Soundness
Unfair or deceptive trade practices notwithstanding, the agencies all have serious concerns about safety and soundness of overdraft protection programs. The guidelines itemize "prudent risk management practices" that institutions should follow in offering the program. These include eligibility standards, well-defined dollar limits and other program criteria, ongoing monitoring of accounts, identification of consumers who do not manage their accounts in a satisfactory manner, disqualification of consumers if appropriate, reports to management, and specific time frames for consumers to pay off overdraft balances. Finally, the program should have a specific time period no longer than 60 days from the first overdraft for writing off uncollected balances.

Credit?
One of the hot issues hovering around overdraft protection is whether the programs should be considered credit. The proposed guidelines had raised concerns about the legal liability of institutions offering overdraft protection. Industry commenters raised strong objections to this aspect of the proposal. The OTS has omitted the legal risk section, but the other agencies have included it. As a practical matter, whether the legal risk section is included or not, the other regulatory issues exist.

Those who offer an overdraft protection program should be very careful. The companies that developed these programs went to great lengths to keep their product out of the reach of Regulation Z, thus saving all that regulatory burden for their clients. But before getting too excited about the possibilities, consider why Truth in Lending and Truth in Savings exist.

If the goal of the overdraft protection program is to make money for the institution, the increase in income is coming from the customer through either increased costs or new costs. The customer should be made aware of these costs and given the choice of incurring them or avoiding them. To fail to let the customer have this choice is fundamentally unfair. Before implementing a program, the institution should carefully review what it has already told its customers and identify what new information it should give customers before implementing the program.

Best Practices
To begin, a note about best practices. These are not voluntary. While labeled as best practices, the policy points out that where supported by a specific law the best practices are enforceable. Since unfair or deceptive trade practice principles could apply to almost all of the best practices if not followed, institutions should take these best practices seriously. As a practical matter, they are much more than recommendations.

First, avoid encouraging customers to manage their accounts irresponsibly. The program should not encourage intentional or frequent overdrafts. Consumers should understand that the program is a safety net only and not a regular service. This issue is high on the list for examiners who are concerned that institutions offering the program may be encouraging their customers to bounce checks - when writing bad checks is technically illegal.

Second, represent the program fairly. Telling consumers about the program's benefits is only part of what you should disclose. You should also tell your customers about the costs of using the overdraft protection. Costs include terms and fees - just like Truth in Lending disclosures.

Fairness also means that you should give customers enough information to choose between overdraft protection programs if you offer more than one. The consumer should understand that choices are available and what those choices are.

Third, best practices must include training. When customer contact staff is explaining the program, they must be able to explain the program correctly and clearly.

Fourth, customers should understand that the program is discretionary. They have the ability to opt out of the overdraft protection. Trained staff should be prepared to explain this.

Fifth, there is a high concern level about the meaning of "free." This is a little like saying a puppy is free to a good home. It's free now, but you will be buying dog food and paying vet bills for years. The overdraft program is no different. If the account can be advertised as "free" under Truth in Savings, the best practices dictate that the costs of overdraft protection be disclosed in a way that explains the limitations of "free."

Sixth, institutions offering overdraft protection programs should clearly disclose program fees. Such disclosures should explain when and how fees will be imposed. Stating that NSF fees will apply is not enough. In fact, it could be deceptive.

Seventh, account or program disclosures should explain that overdraft protection fees count against the dollar limit. Consumers may need this disclosure to understand that the fee is treated as part of the overdraft.

Eighth, if the program will involve multiple fees - and many do - the disclosures should explain when and how multiple fees will be charged.

Ninth, check clearing procedures may be an issue in these programs. If a consumer writes a series of small checks and then writes a mortgage check thinking that only the last check will trigger overdraft protection, your program disclosures should explain that checks clear as they arrive which is not necessarily when they were written. Since large checks have a way of showing up first, consumers need to understand that all of the little checks may bounce instead of only the large mortgage check.

Tenth, and closely related to the ninth concern, play fair. Do not manipulate the check clearing procedure to trigger overdrafts. Follow your stated and disclosed policy.

Eleventh, list and illustrate the types of transactions covered. For example, the customer should understand whether the use of an ATM or an electronic transfer could trigger an overdraft.

The best practice list doesn't stop here. The list includes program features and operations that the OTS expects to see. The twelfth item is that the program should provide the customer options - to select or opt out of an overdraft protection program.

Thirteenth - and this one is tricky - the institution should alert consumers before a transaction triggers any fees. Notice may not be enough. OTS strongly recommends that institutions give consumers an opportunity to cancel the transaction before incurring a fee. This best practice has some interesting operations implications, particularly with respect to check clearing.

Fourteenth, statements and disclosures should make clear distinctions between overdraft balances and account balances. Disclosures and statements of available funds should either not include the available overdraft balance or should clearly identify the overdraft balance as a separate amount. In short, don't indicate to customers that they have plenty of money in the account when they really don't.

Fifteenth, OTS considers customer notice for each overdraft to be a best practice. This notice should be in addition to any notice at the time of the transaction. The other agencies specifically limit the notice to situations where such a notice is feasible. If in these situations, such as presenting a debit card to a merchant, the fee cannot be disclosed, the majority recommend an initial notice to warn the customer. The OTS recommends that the institution consider making the overdraft not available in these situations.

Sixteenth, institutions should consider placing a daily limit on overdraft fees that could be charged on any one account in a single day. This cap would be independent from the overdraft limit. It could be triggered by a larger number of overdraft items with small amounts.

Seventeenth, institutions should actively monitor overdraft usage. Customers that make excessive use of overdrafts may be high risk customers. Institutions should have policies on when and whether to cancel overdraft privileges or offer alternative services.

Eighteenth - and last - play fair when it comes to credit reporting. If the institution is offering and even promoting an overdraft protection program, the accounts using the program should not be reported as problem accounts to credit reporting agencies. This best practice really has two dimensions. First, if you encourage a customer to use a service, the customer can reasonably expect that there will not be penalties for using it - other than the fees. Second, reporting overdraft protection users as problem accounts has echoes of the somewhat predatory practice of not reporting good credit for high risk customers who perform well. Whether in deposit or lending relationships, it is not a fair trade practice to keep the profitable customer trapped.

New Territory
The overdraft protection plans bring up concerns that have not yet been directly dealt with in other regulations. For example, the order of processing checks can have a significant impact on the costs to the customer but there is not currently any required disclosure to explain this. However, the cost impact on the customer may bring this issue into a new level of attention.

The Bottom Line
These guidelines make clear that opportunities for income do not come without a price tag. In this case, even though the program was designed to fall between existing regulatory cracks, the regulatory agencies clearly expect financial institutions to follow regulatory standards. Look to Truth in Lending and Truth in Savings for guidance and use the standards in those regulations as guideposts. Above all, avoid any practice that could be considered unfair or deceptive.

ACTION STEPS

Review your policies and procedures with respect to customer overdrafts. Identify any programs offered.
Review each program for elements that trigger the credit definition of Regulation Z and make sure that any such programs are properly disclosed.
If you offer an overdraft protection program, review account disclosures and marketing materials for accuracy and completeness measured against the best practices.
If you find the word "free" anywhere, either get rid of it or qualify it.
Get a copy of ABA's "Overdraft Protection: A Guide for Bankers" and have appropriate staff read it.
Check your program against the best practices listed by OTS. If you fall short, make necessary improvements.