Should U.S. Policymakers Force Banks to Waive Overdraft Fees During the Crisis?

Should U.S. Policymakers Force Banks to Waive Overdraft Fees During the Crisis?

by Marco Di Maggio and Emily Williams - May 08, 2020

More than 33 million Americans have filed for initial unemployment over just seven weeks and millions more are expected to file in the coming months. The abrupt loss of earnings has stretched many people’s finances to breaking point, forcing many into overdrafts, which can trigger significant additional charges. In response, some banks have voluntarily suspended overdraft charges and, in a few states, notably New York, governors have issued directives instructing banks to waive overdraft fees and lenders to show forbearance on missed mortgage payments.

Unfortunately, many states and banks have not taken these steps, thereby imposing a potentially serious additional burden on the freshly unemployed.

To begin with, the overdraft charge averages $35 each time for any transaction executed on an account with a less than zero balance. What’s more, the number of transactions triggering the fee may well be boosted artificially thanks to a controversial practice - high-to-low reordering of transactions - that is applied at many banks and that maximizes income from overdraft fees.

It works like this: On a $400 checking account balance, a $500 rent debit can be processed before two smaller transactions of $50 each, even if the rent debit was submitted last. In this example, the reordering results in three overdraft fees, rather than just one, which would be the case if the transactions were processed in chronological order. These fees quickly accumulate and are unaffordable for many households who live paycheck to paycheck.

Since banks tend to disclose transaction reordering only in the fine print of deposit account agreements, the practice is extremely difficult to spot. Many banks still practice high-to-low reordering, and overdraft-related fee income is an important revenue stream for banks, providing some $32.9 billion in revenue in 2019, according to estimates by Moebs Services, a financial research company.

Our own research shows that these overdraft fees are a particularly important source of revenues for the banks serving the people least able to afford them, representing in some cases almost 20% of overall bank revenues.

We arrived at this finding by comparing banks’ customer bases with overdraft fee revenues. Using zip code census data, we determined a “hardship score” for each bank, based on the location of its branches. The higher the score, the more each bank holds deposits in zip codes lived in by lower-income households, recipients of government aid, unemployed people, and hourly workers earning at or below the minimum wage - many of them minorities. The chart, fees and hardship, plots the score numbers against overdraft fees as a percentage of revenues and demonstrates clearly that there is a striking positive linear relationship between the two: As of 2019, the higher a bank’s hardship score, the larger the percentage of its revenues from overdraft fees.

We also looked at the flexibility banks display with regard to customers suffering financial hardship during the crisis. Of the largest 100 banks, we found that only 20% offer overdraft fee assistance, and only 7% explicitly offer automatic non-discretionary assistance.

Of the five largest banks, only Bank of America offers overdraft fee waivers, and on a discretionary, case-by-case basis. To find banks that offer automatic overdraft fee waivers, you have to look for those that serve richer customers and that rely very little on fee income from overdrafts, such as CIT Bank and TIAA Bank, whose income from overdraft and related fees is just 0.3% of revenues.

Meanwhile, banks serving poor communities, like Regions Financial Corp and International Bancshares Corp, have not offered automatic overdraft fee waivers and are now set to earn millions in overdraft from the people worst hit by the crisis. On top of that, these same banks are likely to be protected by the government: as stimulus checks have started hitting people’s bank accounts via direct deposit, there have been reports that the money will be used to offset overdrawn accounts and pay overdraft fees.

This suggests a need for government intervention. Unfortunately, that has yet to happen. Senators Cory Booker and Sherrod Brown did recently introduce a bill that would prohibit banks from charging overdraft fees until the crisis is over. “At the height of this pandemic, hardworking Americans should be protecting their health, not worrying about big banks slapping them with fees for small overdraft amounts. This bill would allow them to keep money in their pockets when they need it most,” Brown argued. The measure was not included in the federal relief package.

Doing something about bank account fees of all kinds is way past due. A year before the current crisis, in February 2019, current Federal Reserve Chairman Jerome Powell noted in a speech to the Hope Credit Union, an organization that serves distressed communities in the southern U.S.: “Access to safe and affordable financial services is vital, especially among families with limited wealth, whether they are looking to invest in education, start a business, or simply manage the ups and downs of life.”

Yet according to an FDIC report just a few months earlier, at least 25 percent of U.S. households were unbanked or underbanked, relying instead on non-traditional financial services like payday loans. One of the key reasons cited in the report for not having a bank account? Bank account fees are too high.

Marco Di Maggio is the Ogunlesi Family Associate Professor of Business Administration at Harvard Business School in Boston, Massachusetts

Emily Williams is a professor at Harvard Business School in Boston, Massachusetts