Despite being a cash cow for banks and generating billions of dollars annually in revenue, more banks in the U.S. are moving to scrap or reduce overdraft fees. Given that many fintech companies have thrown down the gauntlet by eliminating overdraft fees levied on customers, big banks have faced pressure to lose this lucrative source of revenue. Additionally, regulators and lawmakers have been mounting pressure on banks to stop charging overdraft fees.

Capital One, one of the largest banks in the United States, announced last month that it was getting rid of all fees for overdrafts and non-sufficient funds. It is estimated that the decision will cost Capital One about US$150 million annually, about 0.5 percent of its 2020 income, according to a report in the Financial Times (January 4, 2022). Ally Bank, Discover and Regions have also ditched overdraft fees.

 

Overdraft fee data insights

U.S. banks earned $6.13 billion in overdraft revenue in the first nine months of 2021, according to S&P Global Market Intelligence data. During this time, Wells Fargo reined in the highest amount of overdraft fees, estimated a little over $1 billion, according to S&P Global.

Banks raked in an estimated $15.47 billion from overdraft fees and non-sufficient funds in 2019, according to the most recent data from the Consumer Financial Protection Bureau (CFPB). Three banks - J.P. Morgan Chase, Wells Fargo and Bank of America accounted for 44 percent of the total overdraft fees in 2019, according to CFPB data.

At a time when more than half of Americans are living paycheck-to-paycheck, the average overdraft fee is at a new record high of $33.58, up slightly from $33.47 last year, according to Bankrate.com’s 2021 annual Checking Account and ATM Fee Study. People living in Philadelphia, Baltimore and Houston paid the highest overdraft fees by metro at more than $35. Cincinnati, Los Angeles and St. Louis paid the lowest fee by metro area at around $31.

 

The financially disadvantaged

People who frequently incur overdraft fees tend to have low incomes, as per the Pew Charitable Trusts. Consumers are charged an overdraft fee when they make payments that exceed the balance in their checking accounts. Low-income consumers incur the fees more than others, and this exacerbates their financial position while producing billions of dollars for banks. 

“Nine percent of account holders paid 84 percent of the overdraft fees,” according to research by the Center for Responsible Lending. “It is the financially vulnerable people who are by far the hardest hit. These customers tended to carry low balances, averaging less than $350.” The research focused on banks with assets of more than $1 billion.

“Rather than competing on quality service and attractive interest rates, many banks have become hooked on overdraft fees to feed their profit model,” said Rohit Chopra, director of CFPB. “We will be taking action to restore meaningful competition to this market.” The U.S. Senate Committee on Banking and Senator Elizabeth Warren, Democrat of Massachusetts, have urged banks to reduce or drop fees and refund customers who were charged excessively.

 

Overdraft fee changes driven by competition

The benefits of eliminating overdraft fees might outweigh the loss. Fintechs and banks that have revamped their overdraft policies are acquiring customers at a faster rate than those financial institutions that have not. According to a study conducted by Curinos, a global data intelligence business that serves the global financial services industry, financial institutions that haven’t adopted overdraft innovation have experienced a nearly 30% reduction in consumer acquisition.

The study, titled “Competition Drives Overdraft Disruption”, found that the current wave of changes to bank overdraft programs is being driven more by competition than regulation. Furthermore, the study enumerates that “the market rewards organizations that overhaul their existing overdraft programs or develop alternative products, and institutions that are slow to act will lose customers to more aggressive competitors.”

While the U.S. banks are moving away from overdraft fees, it’s unlikely that the banking industry will do away with such a lucrative revenue-generating measure completely. Changes to overdraft policies by some fintechs and banks could serve as a model for the industry.

Pennsylvania-based PNC Bank launched the “Low Cash Mode” product that levies a maximum one overdraft item fee per day and 24 hours extra time to bring customers available spend account balance to at least $0 before they are charged overdraft fees.

J.P. Morgan Chase, the country’s largest bank, isn’t eliminating overdraft charges, but is offering its customers leeway on overdrafts before charging a fee. Customers will not be charged a fee if the amount overdrawn in their account is $50 or less at the end of the business day. They would have a full day (24 hours) to restore overdrawn balances to $50 or less so they can bypass a fee.

More banks are expected to offer alternatives to overdrafts or adopt overdraft innovation to give consumers more options. The overdraft fee is not expected to disappear or die, but it will no longer be the irresistibly lucrative revenue source it once was.