The previous blog post presented some background to overdraft (OD) programs, including why they are not horrible programs, providing some data on the demographics of typical users of OD programs. Now, we will look at various possible features of OD programs. There is a lot of room between a strategy that barely allows an OD program, if at all, and one that gives an institution 54% of revenue as fees. I think, sometimes, leaders are timid about exploring options because they want to be invited to industry cocktail parties and avoid tight regulatory oversight. When I find an institution willing to explore overdraft strategies, they face a wide range of considerations.

I will outlay the most liberal program I can articulate to drive maximum revenue, the purpose of which is to provide a framework for the various considerations in OD programs that often go unconsidered. These are not all the considerations, but they should at least get the conversation going. (For example, I’ve left out account-to-account transfers because most institutions don’t hesitate on these features.)

First of all, I would let almost everyone get a checking account at my institution. I would set very liberal guidelines: no more than three charged-off accounts and no more than $500 of principal charged off elsewhere. The cool thing about having the most liberal checking-account policy in town is that customers realize if they mess this one up, they can’t go anywhere else. Some will charge off even still, but many will not, realizing it truly is a last-chance checking account.

Allow as large an OD limit as possible within reason. Many institutions have only a flat $300 or $500 limit for all consumers. Some have tiered limits and review them once a decade. I would have variable limits that are a percentage of a consumer’s last three months of deposit activity. The most aggressive limit I have seen is one that sets the limit at 80% of the last three-month average. It is likely a good idea to cap the limit at around $15,000. I would make the limit rise slowly and decline quickly based on deposit activity.

I would charge off the delinquent checking accounts as late as the law allows for my institution. Ten days or so before that charge-off date, I would call the customer and offer to refund the OD fees if they would make the principal whole. However, they would be removed from the program if they took the deal. More than 80% will choose to pay the fees to avoid leaving the program. I know of one institution that requires a financial literacy/budgeting program for consumers who approach charge-off, repay the fees and want to remain in the program. I had the chance to track a few hundred of these consumers for six months after they took these courses. They generated 30% more in OD fees during the six months following their financial literacy training. They just became more efficient at bouncing items. They managed their cash flow better, but only in the context of managing the OD program more efficiently.

Pricing is important in developing the most profitable program. I would use item-based pricing. It is not based on the amount of the transaction but based on the number of overdrafts in a rolling 12-month window. I would have three tiers: one free item per year, two to four items at my institution’s current price (let’s say $28 per item), and $38 per item for five or more items in a rolling 12-month window. The rationale for this structure is manifold: 1) it places the highest per-item cost on those doing the most items and creating the most risk, 2) I can forgive a fee for those who make a rare mistake, 3) it permanently segments those who bounce more than five items in 12 months, because those who bounce more do not change their behavior (until they are 41 years old) and will stay at the higher tier for the foreseeable future.

The final program aspect to emphasize is the channels through which a consumer could access their OD limit. I recommend allowing all of them: teller, ATM, debit card, check, ACH, bill pay. The strategic OD user (discussed in the last blog post) is particularly prevalent in programs that allow ATM and teller access. Table 1 shows that, typically, more affluent consumers use the ATM as well as the other channels. Such data suggest that allowing consumers to access their OD limits through all channels is not overly onerous on lower-income consumers.

Figure 1: OD Channels Used by Income Segment

As a percentage of each segment’s total OD activity, ATM utilization percentages are relatively high with affluent consumers

^{Source: Raddon Research Insights}

In addition to the program elements, there are some other important considerations when addressing your OD program.

Technology: Can your core system handle it? I never like it when technology drives strategy, but sometimes it is a reality. Some core systems require more effort to tier OD pricing by item, for example.

De minimis exclusions: Many institutions are doing this. All of the above is still applicable regardless of how your institution handles excluding fees for overdrafts below a certain transaction amount.

Opt-In: It’s been a while since we did any consulting regarding this, but ensuring there are many opportunities for consumers to opt in to OD coverage is critical.

Elasticity: I know that some vendors advocate that lower item fees drive more usage. I have never seen any sufficiently powerful research that supports this. Until I do, I will advocate that item fees are inelastic until they reach about $50 per item. At that level, consumers begin tracking their overdrafts more closely.

Buy now, pay later checking: This is newer in the market landscape. From what I have seen so far, it is powerful and worth considering. Early data suggest it fills strategy gaps without substantially diminishing OD revenue. The research jury is still out on this, but it seems to address non-interest income, lending and regulatory concerns.

Instant-access loans: These loans may not truly belong in this blog post, but they are related. I recommend checking out the one offered by Wells Fargo as a thought provoker: Wells Fargo Introduces Flex Loan to Give Customers More Options.

All of the above are important considerations for your OD strategy. I hope your institution has an OD strategy that is intentional and not just set up how your institution has always done it. My only point in all this is to stress that it is not a binary decision. There are many nuances in OD programs and a lot to consider when matching your program to your culture, your strategy and the regulatory environment. Of course, you should run everything in these blog posts by your compliance people; some regulatory variance may apply.