Compliance Bulletin

Analysis of FDIC’s Overdraft Practices Guidance
December 13, 2010

The FDIC issued new guidance on overdraft protection programs (“Guidance”), originally proposed in August this year. The Guidance, which is not released as a regulation,, nevertheless goes beyond the Regulation E changes to one-time POS and ATM transactions. 

Like the 2005 Interagency Joint Guidance on Overdraft Protection Programs, the Guidance focuses primarily on “automated overdraft payment programs,” which are the computerized programs used to help make the pay or no-pay decision based on a bank’s pre-determined criteria. It does not seek to cover ad hoc decisions that a bank makes on an individual basis as a customer accommodation, as the FDIC does not consider these practices to pose similar risks. The main purposes of the Guidance are to reduce over-use of costly overdraft protection by some consumers, and to reduce risks to banks arising from inappropriate practices.

The Guidance putatively applies only to institutions supervised by the FDIC, which are mainly non-member state banks. It was not issued jointly by the federal banking agencies nor through the FFIEC. None of the other federal banking agencies is expected to issue conforming guidance. Nevertheless, there stands a real risk that banks supervised by the other agencies may, to some degree, face expectations to comply with the FDIC’s Guidance. This remains to be seen.

Board Involvement. In the face of industry concerns about the increasing number of regulatory matters that are required to involve direct board supervision, the Guidance specifically requires bank boards to provide “appropriate oversight” of the bank’s overdraft protection program. The Guidance does not explicitly prescribe the degree that bank boards are to be involved, except that its oversight is “consistent with their ultimate responsibility for overall compliance” and includes annual review of the “key features” of the overdraft program. Management retains the responsibility to provide oversight on an ongoing basis, including oversight of third party vendors.

At the minimum, this means that a bank’s program must be included on the board agenda and that directors are provided with sufficient information for them to exercise oversight. However, there are reasons that management should seek to thoroughly engage the board on the bank’s overdraft practices. As this Guidance confirms, bank overdraft practices have caught the attention not only of banking agencies but also other enforcement authorities and plaintiffs attorneys. Without a doubt, overdraft practices will be scrutinized under the upcoming “abusive” standard adopted in the Dodd-Frank Act. As the bank’s board may not be able to avoid direct involvement in the event of litigation or an enforcement action over the bank’s overdraft practices, it would be prudent for the board to be more closely engaged in developing the bank’s policies.

Responsible Use. Banks are also required to ensure that the overdraft protection program and how it is communicated to customers minimize potential consumer confusion and promote “responsible use.” This touches upon the tension between banks’ dual interests in providing a valuable service that generates significant income, and ensuring that their customers are not availing themselves of the service unwisely. This dichotomy has come to light in recent litigation, for at the same time that a bank might make concerted efforts to counsel customers to manage their accounts prudently, it also cannot avoid simultaneously incorporating overdraft fees into their accounting and budgeting processes. Judges and juries may look skeptically at consumer-oriented communications when simultaneously they see that another division of the bank actually counts on overdraft fees to make budget and perhaps even sets overdraft fee revenue targets. Of course, it would be irresponsible for a bank or any other business not to account and plan for a significant source of revenue. But in the context of litigation, the process of discovery almost guarantees that internal documents and communications about a bank’s reliance on overdraft fees will come to light and subsequently be characterized as inconsistent with the injunction to promote responsible use.

Account Balance Disclosures. Banks are to “prominently” distinguish account balances from available overdraft coverage amounts. This general guideline presumably applies to all the ways by which customers can gain access to their account balances. Notwithstanding that bank customers today have unprecedented access to their accounts, the Guidance asks banks to consider using cost effective technologies to alert customers when they are at risk of being charged an overdraft fee. At the very least, such actions would appear to undermine the goal of getting consumers to take responsibility over their financial affairs, and may even place banks at legal jeopardy when they charge a fee without first having issued a warning. Stranger claims have been made in California courts.

Alternatives. Staff must be trained to explain program features and alternatives. Banks will be required to monitor programs for “excessive or chronic customer use.” Specifically, if a customer overdraws an account more than six times in a 12-month period, the bank is expected to contact the customer in person or by telephone to discuss less costly alternatives and to offer a chance to choose an alternative. However, the Guidance does not actually mandate that a bank offer any particular alternatives.

Limits. Banks are to institute “appropriate daily limits” on customer costs such as by limiting the number of transactions subject to a fee or limiting the total amount of fees charged per day, and to “consider” eliminating overdraft fees on de minimus overdrafts. The Guidance does not dictate what those limits are or the amount of overdraft that would be considered de minimus. Also, the Guidance (at footnote 5) borders on price regulation by stating that “If a fee is charged, such fee should be reasonable and proportional to the amount of the original transaction.” No further guidelines are provided to help banks determine an appropriate fee scale. As neither the FDIC nor the other agencies are likely to attempt to dictate direct fee regulation or otherwise prescribe how many times a fee may be imposed in a single day—nor would the industry want that—banks are left to make these decisions individually, if they intend to “comply” with this part of the Guidance at all.

Check Order Processing. The Guidance requires banks to review check-clearing procedures to avoid “maximizing customer overdrafts and related fees through the clearing order,” and suggests clearing items in the order received or by check number as acceptable practices. This raises a question about what defensible reasons remain that a bank could invoke for continued use of high to low processing. One of the most common reasons—that customers are better off and may even prefer to have larger items (such as mortgage and auto loans) paid before smaller items—was assailed recently by a trial court judge in an action against a bank over its overdraft practices. That case, Gutierrez v. Wells Fargo Bank, has not been appealed yet.

The case raised an unanswered question about the extent that the bank would have been found liable had it been able to demonstrate, as it asserted, that its customers indeed preferred the bank to process items from highest value to lowest (the bank could not produce proof). Such a finding presumably would confirm that the bank’s policy is consistent with the interests of its customers and thus could not be viewed as unfair. Whether a bank could demonstrate such a preference strictly through a “consent” written into an account agreement is uncertain. The judge in Gutierrez frowned upon the voluminous agreement used by the bank in that case, and such agreements are not uncommon in the industry.

Steering, Opt Out. The Guidance includes a warning about using the Regulation E opt-in process to steer customers who frequently overdraw their accounts toward fee-based products and away from alternatives. Such a practice could raise fair lending and UDAP concerns, and will be scrutinized. The FDIC further notes that banks “should” allow customers to opt out of overdraft coverage on transactions not covered by Regulation E (such as ACH and check transactions). It is difficult to discern how to construe the FDIC’s intent when it states in guidance, rather than a duly noticed and adopted regulation, that banks “should” allow customers to opt out. The trend has been for banking agencies to treat their own guidance as enforceable regulations for purposes of supervision. It remains to be seen from future examinations whether the opt out guideline becomes the de facto standard. The FDIC also encourages banks to remind their customers, especially those who overdraft their accounts often, that even if they had opted in to the payment of ATM and POS overdrafts per Regulation E that they could “opt-out.” Consumers under Regulation E have an ongoing right to rescind a prior opt in direction.

Examinations. Overdraft payment programs will be reviewed for safety and soundness concerns at each examination and will be factored into examination ratings and, where necessary, corrective action will be imposed. The FDIC reminds banks to follow the 2008 Guidance for Managing Third-Party Risk, 2004 FDIC/FRB guidance on Unfair or Deceptive Acts or Practices by State-Chartered Banks (FIL-26-2004), and Section 5 of the FTC Act (UDAP). Also, the Guidance notes that differentially steering some consumers toward higher cost overdraft protection programs and others to less costly products could result in Equal Credit Opportunity Act violations if done on a prohibited basis, such as by race. Inconsistent application of waivers of overdraft fees could also raise similar concerns. The Guidance states that banks will continue to receive favorable CRA consideration for offering “positive” alternatives to overdrafts such as lower cost transaction accounts, small dollar loans, and overdraft lines of credit.

Finally, other measures that banks could take to protect consumers include providing information on how to procure low-cost or free financial education. In the FDIC’s Financial Institution Letter 81-210, through which the Guidance was released, the FDIC indicates that compliance is expected by July 1, 2011.

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

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