Thursday, January 27, 2022 | Jenny Armistead
This is the time of year when we reflect on accomplishments, strengths and opportunities for improvement. The same is true for financial institutions. If we look back on the past two years, we see the only constant has been change. Those institutions looking to improve and thrive in this environment will be those that embrace change and can proactively prepare for challenges, with a focus on minimizing risk and leveraging opportunity. One of the biggest changes impacting the financial services industry is the evolving overdraft and nonsufficient funds (OD/NSF) fee landscape.
Throughout the past year, there have been many neobanks, fintechs and larger traditional banks that have announced they will either no longer charge their accountholders for going negative or they will significantly reduce the amount charged. These announcements are positioned to shed positive light on the institutions for doing what’s best for their accountholders, but the two drivers of this decision are regulatory/legislative and competitive pressure.
The director of the Consumer Financial Protection Bureau (CFPB), Rohit Chopra, is not a fan of financial institutions that have built their profit model to be heavily dependent on overdraft fees. In a recent statement, he said, “Banks have become hooked on overdraft fees, and the market needs to restore competition based on quality service and attractive rates.” It is only a matter of time that aggressive regulation and enforcement for these institutions will ensue.
As more financial institutions caught wind of the foreseeable reckoning, they understood that it is much better to be among the first to market their new and improved overdraft policy – leveraging it as positive PR versus having it forced upon them. Also, as more financial institutions make this change, it is putting competitive pressure on those who haven’t. You certainly don’t want to be one of the laggards on this shift as those institutions with larger marketing budgets can use this as an opportunity for growth.
Depending on the level of dependency financial institutions have had on NSF/OD fees, they could face a substantial loss of non-interest income. According to a recent Financial Brand article, financial institutions collected more than $30 billion in overdraft fees in 2020. For larger banks, the impact on their earnings model will be minimal. Most of the neobanks such as Chime and Aspiration have never charged for overdrafts, and with their reduced operating expenses compared to a traditional bank or credit union there will be no impact. The institutions most impacted are the smaller community banks and credit unions where a large percentage of their non-interest income comes from NSF/OF fees.
The chart above shows the average household revenue mix and expenses of the more than 300 institutions that participate in Performance Analytics. The amount of net interest income alone is not enough to cover the average total household expenses. Especially operating in this low-rate environment, it is becoming increasingly difficult to maintain earnings. Now is the time for community banks and credit unions to explore alternative sources for non-interest income, such as wealth management and insurance services.
There are two primary options financial institutions can take in response to diminishing NSF/OD fees. If you are large enough and have built your earnings model to easily absorb this financial blow, you can do like Ally Bank and institute a no-overdraft-fee policy. Instead, Ally offers a $10 buffer (fee free) as well as a six-day grace period to allow more time for their customers to bring their accounts current. The bank’s focus is on helping customers with items that may take their accounts negative, so it will not reject subsequent transactions after an account reaches a zero balance.
Another option is to significantly reduce the amount of fees for overdrafts or offer ways to help accountholders avoid the fees. Many financial institutions have gotten creative with their new NSF/OD policies, placing more emphasis on deepening relationships, using technology, and focusing on educating those accountholders who heavily use overdraft protection.
An example of this is Huntington Bank’s Standby CashSM program. Customers must have a checking account with monthly deposits, and eligibility is based on their overdraft history. Once they meet the qualifications, they can receive a digital-only line of credit between $100 and $1,000, which must be paid back in full within three months – interest free with the setup of automatic payments.
The University of Wisconsin Credit Union (UWCU) in the summer of 2021 made the announcement it would cut its NSF/OD fees by more than 80 percent, from $30 per occurrence to $5. It will continue to provide members with a negative $10 threshold, under which no fees will be charged, as well as limit fees to a maximum of one per day. UWCU already eliminated overdraft fees for everyday purchases and ATM withdrawals in 2010.
One reason UWCU was able to reduce its dependency on NSF/OD fee income is its strong relationship-based business model centered on Rewards Checking, which is free if members meet certain relationship requirements. The Rewards Checking option has been available since 2001, and it provides three levels of perks based on factors such as account activity, number of products and maintaining balances. The deeper, more active the relationship, the more rewards available to the member. In 2018, the credit union also offered three new checkless/no-overdraft account options.
This is a great example of a relationship-building strategy that provides the necessary profitability for the financial institution through deeper engagement and higher balances (and not punitive fees), while also benefiting the accountholders. It is truly a win/win for everyone.
PNC’s Low Cash ModeSM is an example of a financial institution using innovation and technology to give accountholders the power to avoid overdrafts. With this new feature in their Virtual Wallet, customers can see what charges are going to hit their account and change the order of the transactions to avoid an overdraft. They can also set up real-time alerts to know when their balance is getting below a self-determined threshold. If they do happen to go negative, PNC’s mobile app includes a 24-hour countdown clock to give the customer more time to bring the account current. PNC has estimated this new service will help its customers avoid $125 million to $150 million in overdraft fees annually and hopes it will drive growth to offset the lost fee income.
It seems like every day we see another financial intuition’s press release announcing their new overdraft policy and how they are focused on helping their accountholders improve their financial health. We know that the CFPB is coming for those that have abused the NSF/OD fee process and relied heavily on it to drive substantial amounts of revenue. Now is the time for your institution to first evaluate what percentage of your non-interest income comes from NSF/OD fees and determine your risk of losing that income or significantly reducing it to gauge how much revenue you will need to generate through other sources.
Once you’ve done your homework, develop your strategy for offsetting this lost revenue. Will you eliminate overdraft fees completely, reduce them or offer solutions to help your accountholders avoid overdraft fees? Will you offer them a grace period to make good, or offer a certain dollar amount they can go negative? How can you use your data and/or technology to make this process easier for you and your accountholders?
There is no one-size-fits-all approach. What is important is that you start planning now and determine a solution that will help you maintain a positive earnings model. The most successful financial institutions will effectively use their data, build deeper relationships, offer alternative profitable services, and drive revenue without punishing their accountholders. The early birds can leverage this opportunity to facilitate growth and goodwill through promoting this new consumer-focused strategy.