Will Regulators Eliminate Overdrafts and Other Consumer Banking Fees?

Lawmakers and regulators have been making a big push to eliminate “junk fees.” Following the Biden administration’s lead, legislators and the agencies are coming after overdrafts and other fees charged by banks and credit unions. 

How does your institution know if it’s charging junk fees? (The definition of junk fees has expanded considerably.) What happens if the agencies significantly limit (or eliminate) the amount you can charge for overdrafts and insufficient funds (NSF)? How much of a revenue kick do these services provide? 

In this post, we’ll sort through the regulatory fog surrounding junk fees, offer insights into what it might take to salvage your overdraft program, and answer the question: what happens to banks and credit unions if this income disappears?

What are junk fees?

The Consumer Financial Protection Bureau’s (CPFB’s) proposed rule on overdrafts and junk fees defines junk fees as fees that aren’t in line with costs. 

The CFPB has been explicit that overdraft fees are a historical mistake – a carveout in the Truth in Lending Act (TILA) intended to help depositors who accidentally overdraw their accounts went on to become a $12 billion revenue stream for financial institutions. 

What about the other agencies? 

They aren’t fond of these fees either. The Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the National Credit Union Administration (NCUA) joined the CFPB in taking a hard stance on “authorize positive, settlement negative” overdrafts (APSNs). APSN overdrafts are charged when a consumer’s account shows a positive balance at the time of a transaction, but posting payments pushes it into the negative.

Reasonable people may argue that consumers should balance their checkbooks to avoid these fees and many industry surveys show consumers want access to overdraft services, but from a regulatory perspective, the days of generating revenue from overdrafts may be numbered.

Financial institutions with $10 billion or less in assets have some reprieve as the proposed rule doesn’t include them – at least not yet. Regulators also want to curb charges for bounced checks, representments (charged by a financial institution when a merchant requests payment multiple times to an account that doesn’t have the funds), and fees to obtain account information.

Consumers would still carry some of the burden for account fees. For example, if a consumer passed a bad check from a friend on the first go-round, regulators would want financial institutions to give them the benefit of the doubt. If they pass a rubber check from that same friend a second time, it may be okay to charge them under the proposal.

But for the most part, regulators want these fees to disappear from the financial services landscape.

So-called junk fees aren’t just related to deposit accounts. In March 2024, the CFPB took aim at mortgage closing costs, arguing that origination, appraisal, and credit report fees, as well as title insurance, discount points, and other fees borrowers pay at closing are driving up the cost of homeownership. The industry is pushing back, arguing that these are fees for necessary services and are properly disclosed in compliance with TRID.

Are mortgage closing costs really on the chopping block? Only time will tell. Mortgage lenders need to keep a close eye on the situation. As the CFPB gathers data on the topic, it’s worthwhile to determine if what your institution charges borrowers is in line with what it costs to provide these services and how it would impact rates if these fees went away.

What will happen to my overdraft program?

At this point, you might ask: What becomes of my overdraft program? Will my customers be unable to buy baby formula at 3 am because their accounts lack sufficient funds? 

Not necessarily. If the CFPB’s proposed rule is finalized, financial institutions will still be able to offer overdraft protection, but they will be limited in how much they can charge for this service.

The CFPB has proposed two solutions for limiting overdraft fees: 

• Financial institutions must prove that overdrafts only cover the cost of their program (making the necessary cost calculations to reach revenue-neutral fees) 
• Overdraft fees can be benchmarked at a lesser amount (the CFPB has suggested fees of between $3 to $14 per overdraft – a far cry from the $25 to $35 fee many FIs currently charge) 

The comment window on this proposed rule is open. Banks and credit unions should submit letters now if CFPB calculations missed the mark or if your overdraft protection program contains additional costs and benefits.

Related: How to Write a Comment Letter on a Regulatory Proposal

How can FIs prepare for the CFPB’s proposed junk fee rule? Will the benchmark rate cover the costs of their program? 

Banks and credit unions might conduct a risk assessment on overdrafts and other fee income. By calculating the actual costs of overdrafts, returned checks, mailing account statements to consumers, and other services, financial institutions can ensure that the fees they charge align with costs. They can determine if the CFPB’s benchmark rates are the best route or if they should devote resources to cost-calculating overdrafts and other fees.  

Regular risk assessments also help institutions monitor the impact of regulatory rule changes at the state level.  

California recently enacted Senate Bill 478 that prohibits “offering a price for a good or service that does not include all mandatory charges and fees.” California's Attorney General warned the Golden State's small banks and credit unions that overdraft and returned deposit fees might now violate California law. 

California’s new law may serve as a model for other states, leading to class-action lawsuits against financial institutions for “hidden fees.”

Moving forward, it will be critically important to ensure that your overdraft program isn’t overcharging consumers and that you follow state and federal laws regarding disclosures.

Are there other options for charging overdraft fees?

There is a workaround for financial institutions that want to continue charging overdraft fees at the same rate, but they may not like it. Banks and credit unions can treat overdrafts as a line of credit. 

Unfortunately, if institutions pursue this option, they’ll be subject to the compliance requirements under TILA and the CARD Act, including disclosures, fee limitations, and periodic account statements. These compliance costs and burdens could easily exceed the revenue generated from overdraft fees.

Is it time to adjust your business model?

While the CFPB’s proposed rule only applies to financial institutions with more than $10 billion in assets, regulators want the industry as a whole to move toward arrangements beneficial to consumers. In other words, don’t be surprised if regulators soon begin to scrutinize the fees smaller community banks and credit unions charge consumers.

Megabanks such as Bank of America have already reduced overdraft fees – in 2022, the bank dropped overdraft fees from $35 to $10 and eliminated NSF fees. This serves Bank of America customers but pressures smaller community banks and credit unions to follow suit. With the proposed overdraft rule, financial institutions will face an even greater challenge in maintaining fee-based revenue streams. 

The limitation or elimination of overdrafts and NSF fees may put a strain on banking budgets. Thankfully, financial institutions have time to prepare. 

Cutting costs is an option. With many smaller financial institutions operating on tight budgets, technology introduces efficiencies that reduce spending on compliance and risk management functions.

Should your institution charge higher interest rates on loan products to offset reduced fee income? Should you focus more energy and resources on growing your deposit base?

Easier said than done comes the inevitable reply from smaller financial institutions.

Recent research from a team of finance professors at UCLA suggests both the problem and the solution for smaller and mid-sized banks regarding interest-rate competition with larger industry players. 

Consumers often bank with more prominent institutions, even when small institutions offer better rates. They accept this trade-off because larger banks are perceived to offer better tech services (mobile banking apps, online bill pay, peer-to-peer lending platforms, etc.). 

Smaller financial institutions understand that they need to embrace digital banking to remain competitive. Lost revenue from overdrafts and NSF fees will continue to fuel the drive for small and mid-sized financial institutions to offer banking-as-a-service applications to consumers. 

The problem is that we’ve seen what can happen when financial institutions aggressively pursue partnerships with fintechs. Community banks and credit unions are drawn to these relationships for many reasons, including as a hedge against the likely decline in fee income. But first, they need risk-based systems and solutions that enable them to adjust their business model and offer the same convenience that attracts consumers to larger institutions.

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