Banks are reaping billions from stealth overdraft charges
At least 1,000 banks are encouraging customers with low balances to overdraw their checking accounts, allowing the banks to skirt credit laws and collect billions of dollars in new fees.
The banks say the programs, which cover checks that would otherwise bounce and even allow people to overdraw their accounts with automated-teller-machine and debit cards, are a service to their customers. But many inside and outside the banking business say the programs, although extremely profitable for the banks, are a bad deal for consumers and amount to high-interest loans.
Washington Mutual, the nation's seventh-largest financial institution and the largest to promote overdraft protection, charged customers more than $1 billion in overdraft fees last year, some industry analysts estimated.
The new "overdraft protection" programs are much more expensive and restrictive than the overdraft lines of credit that banks have offered for decades to favored clients who have big balances or other accounts with them.
Unlike those lines of credit, which typically charge annual interest of up to 20 percent, the new programs charge flat fees for each overdraft that translate into an annual rate of 1,000 percent or more. Unlike traditional lines of credit, which allow repayment whenever the customer chooses, these programs require customers to bring their accounts back into balance in only a few days. Although traditional lines of credit have limits of several thousand dollars, the new programs have limits of $100 to $300. After that, banks allow the checks to bounce.
Typically a bank's best customers, generally best 10 percent or so, are offered traditional overdraft lines of credit, and they are not enrolled unless they explicitly agree.
In contrast, the recent programs automatically enroll almost every checking-account customer who does not have a traditional overdraft line. The programs are used disproportionately by low- and moderate-income people, according to industry consultants who help banks create the programs in return for a share of the fees they generate.
One consultant advises banks to maximize the fees by opening branches "in supermarkets, particularly supermarkets with a middle- to down-market and a family target market."
The rapid spread of the programs has turned overdrafts, and the fees that come with them, into one of the largest sources of profit for banks, according to consultants and statistics compiled by government bank regulators.
But regulators, consumer groups and some bankers and industry analysts say the overdraft programs, which come with fees of up to $35 per overdraft, are essentially high-interest loans aimed at working-class customers. And because the programs work automatically with debit cards, customers often do not realize they have overdrawn their accounts until they receive a letter from the bank disclosing the fee.
"Some banks are looking at the fact that some consumers barely make it from payday to payday and have a very low balance, and instead of offering them a beneficial service, they are charging their customers bounced-check fees to take advantage of the situation," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America.
The programs are a major change for banks, which have long discouraged customers from overdrawing their accounts by charging high fees and warning clients that they are technically breaking the law. Now, in brochures and letters to customers, the banks cheerily promise to make good on bounced checks.
In a brochure describing its checking accounts, Washington Mutual writes: "Overdraft Protection: Did that last check catch you off-guard? Don't worry, we've got you covered." Washington Mutual never explains in the brochure that the program is not free.
A spokeswoman for Washington Mutual said the fees are disclosed when customers open accounts.
Other banks use similar language. Until early January, the Web site for Old National Bancorp, a $9 billion bank based in Evansville, Ind., promoted its overdraft program by asking, "Ever run short between paychecks? Ever been faced with unplanned expenses? If you answered 'yes' to any of these questions, you'll have peace of mind knowing you have the protection of Overdraft Courtesy with your Old National checking account. If you ever need more money than you have in your account, simply write a check."
After receiving questions from The New York Times, Old National removed that language from its Web site. Alan Boggs, senior vice president for Old National, which has 133 branches in five states, said the description was intended to inform people about the overdraft program, not promote it.
"We don't promote it as a line of credit," Boggs said. "It's there in case you make a mistake."
The programs are not widely advertised and instead are marketed mainly to banks' existing customers. Regulators have begun to examine them only recently. The Office of the Comptroller of the Currency, which regulates many large banks, and the Indiana state banking department have warned banks about the programs.
Now the Federal Reserve, which has the ultimate responsibility for overseeing the banking system, is also looking into overdraft protection programs. In November, the Fed asked for comments by Jan. 27 about whether the programs might be covered by laws that require banks to disclose the cost of credit. Depending on how quickly the overdrafts are repaid, their fees translate into an annual interest rate that can reach several thousand percent, far higher than the rates permitted by state usury laws.
Banks and consultants say that using an annual percentage rate to calculate the cost of the overdraft is misleading, because the fee is more like a credit card late fee than a loan.
"This isn't a loan product," said Joe Gillen, chief executive of Pinnacle Financial Service, which helps banks create the programs. "It allows the consumer to have another alternative to manage their funds." Even without the programs, many people would overdraw their accounts, Gillen said. The programs allow them to avoid the inconvenience of bouncing checks.
"Customers almost universally view this as a great service," William Longbrake, the vice chairman of Washington Mutual, said at an industry conference in December.
But critics say the programs are similar to the "payday loans" made by check-cashing outlets and other "fringe banks." Those loans, which are often exempted from usury laws because of their small size, usually cost $10 to $15 for every $100 borrowed and must be repaid in two weeks, terms less expensive than the cost of the overdraft programs.
"The purpose of this is not, in my opinion, to help the consumer," said Philip Goddard, deputy director of the Indiana Department of Financial Institutions. "These programs are only to increase fee income."
Daniel Stipano, deputy chief counsel of the Office of the Comptroller of the Currency, said the programs seem "designed for banks to promote poor fiscal responsibility."
But Stipano said the programs appeared legal under current law and his office had no plans to ban them.
Although banks generally make the programs available to all their customers, statistics from industry consultants show a few accounts generate most of the fees. In many cases, those customers are financially unsophisticated and are unaware until later how much they are being charged, consumer advocates say.
The move to encourage overdrafts is a major shift for banks. In the past, when consumer groups complained that bounced-check fees were excessive, banks generally responded that high fees encouraged people to use their checking accounts responsibly.
"Overdraft fees are intended to be in a sense punitive, because what you're doing is technically illegal," said Diane Casey, the president of America's Community Bankers, a trade group of 1,300 small banks that markets overdraft protection programs to its members. Casey said the programs did not imply that her group supports overdrafts.
"You can view it as an insurance policy," Casey said. "These programs are reflecting the reality of how people manage their finances."
Overdraft charges are the largest part of a long-term move by banks to depend more on fees and less on interest from loans, regulators and consultants say. A study by the Federal Reserve last year found that banks raised their overdraft fees 24 percent from 1997 to 2001, to an average of $20.42. Overall, banks will charge $30 billion in ATM, bounced-check and overdraft fees this year, according to the Federal Deposit Insurance Corp., up 14 percent from 2001. The fees represent about 30 percent of banks' operating profits.
The average bank that aggressively markets an overdraft program will earn as much as $150 on each account annually in overdraft fees, three times as much as a bank that does not, and about $200 in total fees, according to Gowdy.
But overdraft fees are not paid equally by all customers.
In an article on bankstocks.com, an industry Web site, Ralph Haberfeld, an bank consultant, estimated that 4 percent of customers pay half the fees. That estimate would imply that a small group of people, like Gregg, the transplant patient and First Merit customer, pay as much as $2,000 annually in overdraft fees.
Overdraft protection programs "target people that least can afford it," Gregg said. Banks that use them "have got you against a wall, and you just throw up your hands."
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