WASHINGTON–The Consumer Financial Protection Bureau's announcement Feb. 22 that it was targeting overdraft-protection practices was a stark reminder for bankers that even if they have already made significant changes, it is likely not enough.
The agency had been expected to delve into the area, but observers say the industry remains vulnerable despite legal settlements and new regulations.
"The message to the industry is to understand that just because something is a common practice that is not barred by a specific regulation does not mean it's safe," says Jo Ann Barefoot, a co-chairman at Treliant Risk Advisors. "That's the thing that people are being caught by surprise about. They figure, 'if the regulators didn't want us to do that, they would have told us a long time ago.' And now the regulators are getting serious about challenging common practices that are technically compliant, and that's a big danger zone."
The bureau said its inquiry builds on previous efforts by the banking agencies (see story). The Federal Deposit Insurance Corp., Federal Reserve Board, Office of the Comptroller of the Currency and National Credit Union Administration issued supervisory guidance in 2005 outlining best practices for overdraft protection, followed by additional guidance from the FDIC, OCC and Office of Thrift Supervision in 2010 and 2011.
But the bureau warned that many of these practices have not been consistently adopted.
"I think what the [bureau] seems to be saying in the context of their message is, 'Yes, we understand that there is guidance that the banking agencies have issued, but we question the extent to which the industry is following it and the extent to which it's been enforced,'" said Kevin Petrasic, a partner with the law firm Paul Hastings Janofsky Walker and a former Office of Thrift Supervision official.
Consumer advocates hailed the move, which they said could help bring a more comprehensive set of standards to the overdraft space.
"Although the Fed rules require that banks get consumers to opt-in to pay overdraft fees on two types of transactions, there is no limit on the frequency of fees, or the dollar amount of fees, or how many fees can be charged for a single overdraft, or whether the fees bear any relationship to the cost of extending credit, which is what banks are doing when they cover your transaction," said Jean Ann Fox, the director of financial services for the Consumer Federation of America.
Susan Weinstock, the director of the Safe Checking in the Electronic Age Project at the Pew Charitable Trusts, said there is still a lot of confusion among consumers about what it means to opt in to overdraft protection.
"Making sure that the options for consumers are laid out, and that consumers understand that they do have options," she said. "We think we need changes to regulation and we think that [the bureau] can do that, and we think this is a great way to start going down this road."
The bureau intends to look at four areas in particular: reordering of transactions, missing or misleading information about the terms of overdraft programs, how those programs are marketed and whether they have a disproportionate impact on low-income and young consumers.
"Overdrafts can provide consumers with needed access to funds, but the growing costs of overdraft practices have the capacity to inflict serious economic harm," bureau Director Richard Cordray said at a roundtable discussion with banks and consumer groups in New York (see story). "We want to learn how consumers are affected and how well they are able to learn about the costs and risks of overdrafts."
The bureau has requested data from large banks about their overdraft-protection practices, and is launching a campaign to let consumers know what they can do to avoid overdraft fees.
At the panel discussion, representatives from several large banks said they have already taken steps to make their overdraft programs more consumer-friendly.
Bank of America eliminated overdraft protection for point-of-sale transactions last year, and now provides a "clarity statement" to new customers that outlines the terms in plain English, said Andrew Rowe, a senior vice president at the bank. And Citibank processes checks and ACH transactions from low to high to minimize potential overdrafts, said John Carey, Citi's managing director of global consumer banking, governance and external affairs.
But observers said banks are still at risk in some areas.
Petrasic said the guidance regulators issued in 2005 outlined a slew of legal issues that are tied to overdraft protection, including the Truth in Savings Act, Truth in Lending Act, the Electronic Funds Transfer Act, Regulation E, Regulation Z and UDAP violations.
"You could end up kicking in a number of potential federal law consequences, and obviously state law issues too, as a result of an institution marketing a program inappropriately," he said. "I think that there are some vulnerabilities that the institutions have to pay attention to."
Banks are particularly likely to be challenged, especially in areas where the practices have long appeared to be legal, Barefoot said.
The bureau said it intends to revisit a 2008 FDIC study that found that 9% of checking-account customers bear 84% of overdraft fees, and that 46.6% of young-adult consumers have incurred overdraft fees.
"Any time a product is making disproportionate amount of income from a segment that is perceived to be vulnerable and less able to make a good choice, less able to protect their own best interest, then it's more of a UDAP red flag," Barefoot said. "That doesn't mean it's necessarily illegal, but it does mean that the bank should be thinking about being comfortable that they can defend what they're doing."
Barefoot said banks should also be paying attention to what percentage of income is coming from overdraft fees.
Should banks be worried about the bureau inquiry itself?
Oliver Ireland, a partner with the law firm Morrison & Foerster, said no, but they must be prepared to educate bureau officials.
"I think there are some areas that could stand some standardization, clarification, but I think mostly there's a lot of potential for harm here," Ireland said. "And the banks really need to pay attention to it and make sure the [bureau] understands what the practices are, and why they make sense for consumers, so that they don't do something based on a misunderstanding of what's go on and why it's going on."
Jackie Stewart contributed to this article.
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