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Below is a lightly edited transcript of the episode:

ROMAN: So at the time, I wouldn’t say I was, you know, low low income. I can share what I was making, it was like, $45,000 at the time. I mean, I lived in New York, which put me above my means. And, sure, that was a decision that I kind of made. But at the same time, you know, that amount of money was enough to pay my food, my bills and everything else that I needed to do. There was just some sort of overlaps that occasionally, you know, I wasn’t saving anything, but I was able to survive.

LAURA ALIX: This is my friend Roman, and he’s telling me about his experience with overdraft fees.

ROMAN: And I bounced, I believe, two rent checks. And then I got an additional overdraft fee. And the bounce was because the time that it took for my paycheck to deposit, versus the time that it took for the check to clear was different. I was with, I believe, Bank of America at the time.

ALIX: Did you try to get that reversed?

ROMAN: I reached out to Bank of America, it was a very long process. They did not reverse it, claiming that it is not their fault.

ALIX: Okay. Okay, so it really wasn’t anything, it kind of was just a timing issue. It wasn’t you writing checks you can’t cash?

ROMAN: Yes, it was a timing issue. However, I mean, I didn’t have any money in the bank account. When I wrote the check, I just was banking on the deposit coming in the next day, which it was supposed to, and clearing before the check was cleared. And that timing didn’t occur.

ALIX: Roman’s story isn’t super unique — in fact, you can read thousands of stories just like his in the Consumer Financial Protection Bureau’s consumer complaint database, all of them complaining about the subject of this episode: bank overdraft fees.

You almost certainly know what a bank overdraft fee is — maybe you’ve maybe even gotten a few yourself (this is a judgment-free zone). But the way overdrafts work is this: let’s say you swipe your debit card for $60 worth of groceries, but there’s only $50 in your account. When that happens, the bank covers the payment you made, making your account balance -$10.
But the bank will also hit you with an extra fee for that service — typically around $35 — making your new balance -$45.

Banks say overdraft fees are meant to discourage overdrafts, and by extension keep consumers from spending beyond their means. They also offset the costs to the bank of covering overdrafts, as well as the costs associated with offering checking accounts. And what is more, many peopledowantimportant payments like rent and utilities to be covered, rather than bounced back to the person they owe in the first place.

But overdraft fees are also widely seen as kind of a wrong-way subsidy. People who incur overdraft fees almost by definition have less money in the first place, and may also have less predictable incomes for any number of reasons. And beyond having lower or less-predictable incomes, some research suggests that women and Black and Hispanic people pay more in overdraft fees than white men. And there’s a growing consensus that overdraft fees are a major factor that ultimately pushes low-income people away from the banking system altogether, and towards check cashers, payday lenders and other more expensive financial services. And the coronavirus pandemic, the rise in unemployment and nationwide protests over racial disparities have made only added urgency to this issue.

So what is there to do? Is the current arrangement the best banks can do? Would some kind of regulatory solution make things better for consumers? And are there better ways to make low-cost checking services widely available that don’t hurt lower-income consumers the hardest?

From American Banker, I’m Laura Alix, and this is Bankshot, a podcast about banks, finance, and the world we live in.

As I said a moment ago, there are thousands of stories like Roman’s and thousands of consumer complaints about overdraft fees. But that’s all anecdotal — how big of a revenue stream are overdraft fees in retail banking?

LESLIE PARRISH: Over $11 billion in overdraft fees are collected by banks every year. And the vast majority of bank customers actually don’t pay any of that amount.

ALIX: This is Leslie Parrish.

PARRISH: My name is Leslie Parrish, and I’m a senior analyst at the Aite group. And I do a lot of research on consumer lending, and things that could be considered alternatives to loans, particularly to low- and moderate-income Americans, like overdraft fees.

ALIX: The Aite Group is a financial research and consulting firm based in Boston, and as we mentioned, those overdraft fees are not paid by everyone equally.

PARRISH: It’s really just a small portion of folks that are responsible for the lion’s share of overdraft fees. And those people tend to be pretty financially fragile. They generally don’t have a lot of other types of credit options, they’re less likely to have a credit card — and even if they do have a credit card, they don’t have a lot of available credit that they can spend on that card.

ALIX: Early into the pandemic (which by the way, is still going on), a lot of banks voluntarily paused overdraft fees, or pledged to work with customers individually (which: OK). But all of that consumer relief is voluntary and highly variable from bank to bank. There’s no industry-wide agreement on what to do about overdraft fees during the pandemic, and while regulators have encouraged banks to play nice with customers during the pandemic, there’s no regulatory guidance or mandate about how to do that. And that inconsistency is spurring some consumer advocates to make the case that the entire overdraft fee framework needs an overhaul.

PARRISH: Until recently, debit cards were really the driving force behind overdraft fees. And a lot of that is just because debit cards are used very frequently by consumers. So there’s more chances for a slip up. And you would hear about, you know, this $40 cup of coffee where someone overdo their account by just a couple bucks in a coffee shop, and then was unwittingly paying a $34 overdraft fee for the privilege of buying that coffee. That has changed somewhat in the recent past, which is a great thing. Because many banks have changed their overdraft policies so that if you ever dropped by just a small amount, you’re not going to be charged that overdraft fee, but that’s not universal. Not all banks have that policy.

ALIX: And part of what is hard about making broad changes to overdraft fees is that banks have come to really depend on those fees.

PARRISH: Many banks across the board have really grown pretty reliant on overdraft fees as a revenue source. But, you know, the biggest things I would say, you know, have a lot of other revenue streams that they can draw on. So, if you just look across the spectrum, there are a large number of community banks and even credit unions that are really heavily reliant on the revenue source of overdraft fees, really just because of the lack of other streams of revenue relative to big banks.

ALIX: So how did we get to this point, and that proverbial $40 cup of coffee? I asked Ginny O’Neill.

GINNY O’NEILL: My name is Ginny O’Neill, and I am an executive vice president with the American Bankers Association. And my area of expertise is consumer protection regulatory issues, and have … worked on overdraft either directly, when I was ABA staff, or overseeing other people’s work on overdraft since I joined ABA in 2008.

ALIX: O’Neill explains it this way: Thirty years ago, if you wrote a check, you could probably count on having at least a few days before the money actually came out of your account. If you didn’t immediately have the funds to cover it, but you knew you had a paycheck coming soon and you just needed to get the check in the mail, you had a little bit of a grace period. But eventually, check processing got faster and those grace periods got shorter.

O’NEILL: What happened was people would, you know, a check presented on insufficient funds would either be paid by a bank, or it would get returned. And the fee charged in those cases was always the same. And it tended to come with a stern warning about overdrawn your account because it’s illegal to overdraw your account. And it was intended like a speeding ticket to discourage that activity.

ALIX: And then came debit cards. Debit cards have been around since the 1970s, but usage started to really pick up in the 90’s. By 2009, consumers were processing almost 38 billion transactions with debit cards. And that means a lot more opportunities for consumers to overdraft their accounts. O’Neill says that many overdraft programs were initially motivated by a desire to treat all of their customers equally.

O’NEILL: What happened was that overdraft protection programs are created in an effort to treat all customers more fairly and consistently. So banks would formalize a program, and they would disclose it. So they would say, we are going to offer to customers, say $500 overdraft ability… if the bank saw that people had regular deposits coming in and out of the account, then then customers could make an informed choice to write a check, and incur an overdraft fee, rather than have the item returned by the merchant and incur the late fee on that bill, or the return check fee.

ALIX: In 2010, the Federal Reserve wrote a rule stating that banks have to get their customers’ consent before they could charge overdraft fees, also known as the opt-in rule.

O’NEILL: The consumer testing showed that most consumers want to check transactions and ACH transactions to be paid into overdraft. Typically those are for large amounts, like think about yourself, you pay your mortgage, your utility bills, your cable with either a check or an ACH transaction. Those are important for you to have paid, and you want those to go through. What they found, though, was that consumers probably needed a little bit more of a warning, and an opportunity to choose whether point of sale debit card transactions should be paid into overdraft.

ALIX: But consumer advocates say there are still some problems even with that rule in place. This is Rebecca Borné, Senior Policy Counsel with the Center for Responsible Lending.

REBECCA BORNÉ: What followed was an aggressive effort from financial institutions to get consumers to opt in, so that they could continue to, you know, hammer people with overdraft fees. And that’s what happened. Um, we see examples of financial institutions deceiving people into opting in.

ALIX: Borné said that one recent example is TD Bank, which paid $122 million to settle charges by the Consumer Financial Protection Bureau that it opted customers into overdraft programs without their consent.

BORNÉ: But TD Bank shouldn’t be seen as some, you know, outlier. All financial institutions have the incentive to try to get people to opt in, you know, because the rewards or the financial institution are so great once they do, you know, because there are literally billions of dollars that banks are draining from customers every year from this program, these programs.

ALIX: Overdraft fees are supposed to help a bank cover the cost of fronting the money that’s not in a customer’s account when a payment clears. And that’s a legitimate reason to charge a fee — it costs money to clear a transaction when an account has insufficient funds, and if the customer just abandons the account and never deposits anything back to cover it, the bank is holding the bag. That’s a real thing that happens. And beyond that, just having a checking account infrastructure costs money as well. One industry study put that cost around $20 to $40 per checking account, per month, just to give you an idea.

Put another way, free checking accounts tend to cost banks a lot to operate and maintain. Overdraft fees are a common way of recouping those costs, but according to a comment letter that the ABA sent to the CFPB in 2013, overdrafts only cover about 30% of the overall costs of offering checking services.

What is different about overdraft fees versus other ways banks can recoup those costs is that there is a dimension of morality surrounding who pays those fees and who does not. Fee-payers are those who overspend on their balance — in that sense, the fees serve as a means of discouraging bad behavior. You’re not supposed to spend more money than you have, and if there’s a penalty when you do and it hurts enough, it might keep you from doing the same thing again. But is that really as fair as it sounds?

PARRISH: Banks often say that they charge a high overdraft fee, because it needs to be punitive, it’s a penalty fee for a bad action. They want to discourage people from very being irresponsible in their management of their bank account. But it’s a bit schizophrenic, when you think about how reliant banks have grown to grown on this revenue source. So they need overdraft fee income, but that only occurs if people are irresponsible with their bank accounts. So I don’t really think it’s a punitive fee anymore. I think it’s actually now positioned as more of a service. But those two messages, whether it’s a penalty fee or whether it’s a service, are really at odds with one another.

ALIX: Regardless of whether it’s a service or a punishment, an overdraft fee is $35 fewer dollars that the customer has to spend on other things. And that compounds the underlying problem for those consumers who disproportionately rely on that service or incur that penalty — they lack a regular and/or adequate income to cover their expenses. More on that after this short break.

ALIX: To understand why overdraft fees are a problem, you have to understand why the people who end up paying those fees get hit with them in the first place.

MELISSA GOPNIK: What we’ve learned is that people don’t incur overdraft fees because they’re bad at managing their money. They incur overdraft fees because banks are not set up to meet their financial needs. Lower income Americans have specific financial needs, and banks don’t meet them. So it’s no surprise that they don’t use banks. And in fact, overdraft fees are an example of a specific way that they don’t meet the needs that they have every day, if I’m helping to manage their finances.

ALIX: This is Melissa Gopnik.

GOPNIK: My name is Melissa Gopnik. I’m a Senior Vice President at Commonwealth. Commonwealth is a national nonprofit organization, whose mission it is to build solutions to the financial challenges faced by lower wage Americans. I lead up our innovation lab where we get have the fun task of coming up with new great innovations to help people who are in the lower income bracket in this country.

ALIX: When academics and policy wonks and reporters like me talk about lower-income consumers, we tend to think of the defining feature of being lower-income is that you make less money, have less money to spend. But Gopnik said there’s another prevalent feature for low-income earners as well, and that is the irregularity of income — you never quite know how much you will be paid, or when.

GOPNIK: When we often say people are living paycheck to paycheck, we have this illusion of that means it’s the same paycheck week after a week. And it’s not for most hourly workers, it is not the same paycheck week after week. And to imagine what it’s like to manage your finances, not knowing how much income you’re going to be getting every week. And that’s when overdraft fees comes in. If you don’t know exactly how much income it’s really hard to predict how to pay all your bills.

ALIX: Gopnik told me that as one possible alternative to overdraft fees, banks could offer overdraft lines of credit, as an example. The bank earns some interest income from that product, and the customer pays that interest on a predictable schedule and gets important payments covered — and presumably for less than $35 a hit. There’s reason to think this could work, Gopnik said, because banks already do this for wealthy people.

GOPNIK: So imagine if instead of charging low-income people overdraft fees, imagine if you had a customized line of credit for all of that. Given data … you know, data intelligence, it will be super easy for a bank to come up with a customized line of credit for all of their customers that would meet their needs and be more affordable than the current one-size-fits-all overdraft fee.

ALIX: One challenge there is that a line of credit is, well, a line of credit. That’s very different from a fee, because a bank needs to underwrite a line of credit where they don’t underwrite a fee. And because it’s a line of credit, borrowers with lower credit scores may pay more for that service, which makes it all the less egalitarian.

One thing I heard a lot in reporting this story is that the problem isn’t fees, at least not necessarily. Fees aren’t inherently evil. The problem with overdraft fees specifically is that they’re often unpredictable and not designed to be sensitive to the proportion of the offense or the customer’s circumstances. And for a customer who’s already living on somewhat limited means, it can feel like pouring salt into an open wound.

So if the problem isn’t a fee, but who pays it and when, couldn’t banks just charge everybody a small monthly maintenance fee upfront — say $5 or so — and use that fee to pay for overdraft protection? Even people of limited means might rather pay $5 a month, every month, and just know that they aren’t going to get dinged $35 if the rent clears before the direct deposit does.

GOPNIK: What we’ve learned in our research is that people are fine with paying a fee for good service. They’re fine with paying a fee when it’s predictable, and they get something of value out of it. Because you have to understand people’s lives are so unpredictable and so volatile. The last thing they can have time for is to figure out what my fee is going to be this month, and if you can take that away, that’s … that’s wonderful.

PARRISH: I think there is a slow change underway among some banks, recognizing that, you know, there’s really a significant disconnect between charging a bunch of overdraft fees to someone who’s already a bit financially fragile, and a bank, you know, messaging that they want to be their customers partner and achieving financial wellness, those, those two dynamics are kind of at odds. So there is a big market opportunity and some of the challenger banks have ceased trading accounts that are that that, you know, don’t charge any overdraft fees or even provide other alternatives that are much lower cost when people don’t have enough money to make ends meet.

ALIX: Some bankers say the industry is already starting to move away from reliance on overdraft and nonsufficient funds fees. Even before the pandemic happened, fintech firms and so-called challenger banks seized on overdraft fees as a pain point for consumers fed up with brick-and-mortar banks.

And more recently — by which I mean within the past 3 months — a few big banks have launched new checking account products that promise $0 overdrafts for a small monthly fee. One of them is Key Bank, and the guy who is going to tell you about it is Chris Manderfield.

CHRIS MANDERFIELD: My name is Chris Manderfield. I am the head of public management for Key’s consumer bank. In that capacity, my team and I are responsible for household acquisition, fee income, deposit pricing and portfolio management, consumer lending and our auto business.

ALIX: Manderfield said the long term idea here is that people will stick around longer and come back for other needs — say, a mortgage or a car loan — if they have a good experience with a lower-stakes product like a checking account. And part of what makes a checking account experience “good” is how a bank deals with overdraft fees.

MANDERFIELD: If we are a primary bank for a client, disproportionally we will see more volume from a flow of funds perspective into Key, and it will stay comparatively longer, than if we don’t.

ALIX: So while checking accounts cost money, as we described earlier, they also serve as a kind of gateway to more profitable financial products — come for the checking account, stay for the mortgage. So finding another way to fund checking besides overdraft fees is really a matter of diversifying a bank’s fee income streams. In other words, if a bank can also count on other types of fee income like credit card interest, mortgage fees or investment income, then overdraft fees are a lot less important.

MANDERFIELD: I continue to think that you will see continued movement away from the OD and NSF line and their reliance on that. As relates to low- and moderate-income households and clients, I don’t see it necessarily being a deterrent, and I think, candidly, I do think there’s going to be a continued movement from a product design perspective, and fee structure perspective, where you’re going to see banks be less austere in terms of marginal overdrafts. And so rolling out ade minimispolicy, if you will, on the OD and NSF side is where I see the industry moving. I think with that movement, you will see a new — and for all intents and purposes, underserved — community, gravitate towards institutions, once those changes are made.

ALIX: A minor point here, when Manderfield says “de minimis,” what he means is that for an overdraft below a certain threshold, say $10, the bank will pay the charge and deduct the balance from the next deposit that comes in, without tacking on the fee.

But even if there’s a business case to be made that overdraft fees are on the way out, that doesn’t necessarily mean change will be uniform or swift. That’s why Borné of the Center for Responsible Lending says bank regulators need to step in and set some clear and consumer-friendly rules on overdraft fees.

BORNÉ: The current overdraft system is a pretty clear example of where we need across-the- board regulation. Okay? This problem can be fixed by financial institutions, shifting their pricing away from back-end overdraft fees, and toward upfront checking account monthly checking account fees. But most banks don’t want to do that on their own, because then they are the bank that’s now charging, you know, $10 a month for a checking account. And that they view as a competitive … competitive challenge, you know? And so it’s where we need across-the-board regulation. We need a rule from the CFPB. They were heading in that direction before leadership changed. We need a CFPB with the will to address this latent abuse of practice pervasive in the industry. And we need a rule that calls this practice what it is, which is credit, and it should have the protections of other credit products and banks should be able to — should be required to — ensure that consumers have the ability to repay the credit that they extend it, and they should have to extend the credit on fair terms.

ALIX: But regulation is a blunt instrument, and while it can set standard rules for the banking industry, it can also push an entire industry in one direction or toward one solution that may not work for every bank. And the various alternatives that banks are already coming up with illustrates the various ways of solving this problem. This is Ginny O’Neill again with the American Bankers Association.

O’NEILL: You have many, many banks, I’d say probably most of them do offer a no overdraft account. It typically comes without checks, because you can’t completely control checks that they offer the checkless checking account where you cannot overdraw. And for many people, that’s a great option. You also see, like a Huntington bank announced this week, they have a $50de minimis. So if you overdraw your account by less than $50, so that $5 cup of coffee, you they’re not going to charge an overdraft fee, they also give an A 24 hour grace period. So if you have overdrawn your account, and you get the notice, you have 24 hours to go in and make a deposit. Capital One is another one, they have a 24 hour grace period as well … as well as the opportunity for setting up an automatic transfer from your savings or money market into your checking account to cover an inadvertent overdraft. There are many examples of banks sort of assessing where they want to be in the market and, and what their consumers need. And we’re all for that. Not for people, you know, either through regulation or legislation, dictating one-size-fits-all products and services for everyone.

ALIX: But however this gets resolved by regulators — indeed, whether regulators take up this issue at all — customers will have to manage overdraft protections on their own, either by making more money, spending less money, or finding a better service. Obviously just making more money isn’t something everyone can just decide to do, and in many cases spending less money is equally hard — they’ve already foregone the $5 coffees long ago. My friend Roman, for example, hasn’t had an overdraft in years, but he says it’s not because overdrafts taught him a lesson.

ALIX: Do you feel like that experience taught you to be more responsible with your money? Or did it kind of just —

ROMAN: No, it taught me to choose a better bank. But aside from that, no, I think that overdraft fees. I mean, inherently, they affect people that at whatever point in their life, like, right now, this, this wouldn’t be a problem for me, but at the time, getting a — you know, $25 $50 overdraft fee was huge. When you’re on your first job, and you’re living paycheck to paycheck, and you’re also paying student loans and everything else, that’s when you’re most likely to bounce checks. So it’s not that I’m financially irresponsible, it’s that I have more going out than is coming in at a given time. And the you know, like, the grace window of a few days, or the understanding that the fact that I bounced the check of something that we should work to make sure it doesn’t happen again, versus, you know, hey, pay me more money now that you don’t even have that money is probably a bad decision by the banking community. And it certainly alienates me from using banks that are unforgiving about it.