Saturday, May 29, 2010

A new approach to overdraft fees

In the recent clamor for the reform of finance regulation--a process I have not followed very closely--there is much ado about the bank overdraft fees* and about ways to use government regulation to curtail what are considered the more extreme fees. I think this is a real problem that admits of no easy solution, but one reform that might help would be a policy to encourage banks to develop what I'd like to call "money order plus" accounts.

First, an example of what the problem is. When I worked as a customer service rep at an in-bound call center for a bank in Colorado, I encountered quite a large number of people who incurred very stiff fees for overdrawing their accounts, sometimes to the tune of hundreds of dollars. (I realize my perception might be skewed in that the people with overdrafts are probably more likely to call customer service than are people who manage their account better.) To my observation, there several causes of such extreme overdrafts:
  • Irresponsible spending, or writing writing checks without taking proper account of the fact that the check writer doesn't have enough money. Believe it or not, I've actually known people who've confessed to me that they assume they have money as long as they still have unwritten checks in their checkbooks!
  • People who make small mathematical errors, and because of the bank's check clearing practices, end up paying a large number of overdraft fees. (Banks usually choose from among three basic ways of clearing their checks when several present on the same business day: 1) clearing by check number, usually clearing the lowest check number first and moving up; 2) clearing by the amount for which the check is written, and clearing the smallest amount first and moving to larger amounts; 2) clearing by the amount for which the check is written, and clearing the largest amount first and moving to smaller amounts.)
  • People in desperate circumstances who have found it necessary to pay, for example, their rent against an overdraft in hopes that it will clear and stave off more severe consequences (such as eviction).
  • People who mistakenly rely upon promises by the payee to wait before cashing a check, or who rely on the fact that they have postdated a check, or written a later date for cashing the check. (As general practice, banks usually pay on postdated checks if they are presented during the proofing process overnight. At teller stations, banks usually do not, and I am unsure about the protocol when banks clear checks electronically. It's possible that some states have different regulations, but in Colorado, apparently, banks were allowed to do this, at least when I worked there. In fact, in the fine print of the account agreement, the bank said it would clear such checks if presented. Maybe there is an opportunity for legal recourse here, but such an opportunity is often impractical for people who are so affected.)
  • A bank error or compromised account (checks or debit card are stolen) leads to overdrafts that the customer did not legitimately incur. In cases like these, the bank usually (but alas, sometimes grudgingly**) waives all overdraft fees.
The hundreds of dollars to which these fees sometimes amounted seemed, to me, disproportionate to the "crime" the customers had committed, and my ability to refund fees was limited.*** So, for example, I more than once faced the situation where a single mother would be crying into the phone begging me to refund some of her fees. There were other, desperately poor, people who continued to overdraw their accounts.

Now, the customers bore a goodly share of the responsibility here. They agreed to have an account and they implicitly accepted to abide by (and they probably refused to read) the rules which the bank had set up for clearing checks. They had overdrawn their accounts. In short, they had trouble managing their money. But it seems to me there must be a better way, for the following reasons:
  • Bank accounts, are almost a necessity in today's economy. It is possible to get one's check cashed without an account, but it is more difficult and dangerous. Usually, the check recipient has to pay a fee. He or she then has to deal with the danger of carrying, for example, his or her weekly wage around before purchasing money orders or paying cash.
  • Checking accounts, in particular, are also a necessity. Secure money orders are quite expensive, say $2 or $3 (at some banks, sometimes even up to $5 for bank customers, although at other banks, and especially credit unions, money orders are free), especially for poorer people. Cheaper money orders are available, for example, at 7/11, but the problem with these (and with most money orders in general) is that while they are better than not having any monetary instrument, it is often difficult to verify payment in case the payee claims not to have received payment.
Now, some proposed solutions involved invoking government to set or limit the amount or number of fees a bank may charge. I have not looked very closely into such schemes, and there may be some merit to them. But price-fixing schemes sometimes backfire in ways not predicted by their advocates, or they fail to address the problem at hand. For example, recent reforms have limited the types of fees and amounts of interest that credit card companies are allowed to impose on customers. The result: these reforms have served as justification by the companies to lower credit lines, to deny credit to marginal customers (who now would increasingly have to resort to payday loan schemes), and to impose annual fees on customers who before did not have to pay them. (It is possible that this is just a ploy to "gouge" customers. I don't know enough to comment knowledgeably on that aspect, but I suspect that these moves by the credit card companies--especially the denials of credit to marginal customers--are at least partially caused by the new regulations and not purely by corporate greed.)

I have another plan, one that would supplement other financial regulations (in other words, I am not going to dismiss out of hand the prospect that fees may somehow be limited by the government to good effect, even though I don't at this time endorse such a measure). That would be to create incentives for banks to develop what I call "money order plus" accounts. Such accounts would have the following features:
  • They would be essentially "savings accounts" from which customers could expect quick availability of their deposited funds.**** ]
  • These accounts would offer the ability to purchase cheap money orders in the customer's name (most money orders are customarily in the name of the bank or a third party, such as Traveler's Express, with which the bank contracts for selling money orders) for those bills that require non-cash payment.
  • Payment on these money orders would be verifiable, and customers would be able to order copies of paid money orders in order to prove payment. (In a sense, these money orders would work as "certified checks," drawn off the customer's account.)
  • Customers could stop payment on these money orders, which can't be done now with standard money orders (at least not to my knowledge).
  • Customers could get prior approval for their money orders. For example, say a customer wants to get a money order ahead of time for his or her electric bill, but doesn't know precisely how much the bill will be but knows that it will be, for example, around $50. That customer could get an approval--which would be essentially a self-imposed hold on his or her funds availability--for a larger amount, say $60 in this example, and when the bill turns out to be, say $51, the customer could make the money order for $51, and it would clear the bank for $51, and at point the remaining $9 would be made available to the customer. Under this system, the customer could not write the money order for more than it is approved, and could not use the $9 until either the check clears or the customer stops payment.
  • ATM's would be reconfigured so that a customer could use his or her ATM card to get pre-approved money orders as well as cash. (Under my plan, the customer could have an ATM card for cash withdrawal, but could not have a debit card.)
  • The virtue of having these money orders would be that payment cannot be made without available funds. Therefore, it is less likely that a customer could overdraw his or her account. (There are still marginal possibilities, say when a check that is deposited has been returned by the maker's bank, or when banks that operate "off line" cannot notate automatically a withdrawal. My plan doesn't address these issues.)
It would be largely up to the banks to establish such plans, and therefore my blog post is at least in part an attempt to offer to banks the possibility for a new type of account. (For all I know, I am reinventing a wheel that already exists, or that used to exist but does no longer.) But I think there are things government can do.
  • Create a different tier for FDIC insurable accounts. One that is, in essence, create an account that requires more reserves than a savings account now requires but one that requires fewer than a checking account does. (These requirements are based on aggregates, if I understand the system correctly. But it's convenient to think in terms of "reserves required for each account.")
  • This account would have to offer the money order scheme I outlined above.
  • These accounts would not necessarily be required to charge interest, but would have to be "free," that is, have no minimum balance requirement or monthly service fee. There would be no debit card access and no automated withdrawal (ACH) access, except for when the "money order" would be cleared electronically by the payee.
  • These accounts would be required to offer a given number of money orders per month for free. I would prefer a higher number, say, ten (10), but I would like there to be no fewer than five (5) that are free. The idea is to give people enough "money orders" each month to pay their bills. The price of any greater number of "money orders" would be pegged to the price charged bank customers for cashiers checks.
  • There would be limits on the degree to which banks may use a customer's credit history to deny access to this account.
There are some potential advantages to my plan:
  • Banks would incur fewer overdraft costs. On one level, this might be bad for the bank's bottom line (fee income can be a not insignificant share of a banker once told me, it costs $20 to pay one overdraft check, but it doesn't cost $40 to pay two.) On the other hand, it would not have to devote some many employee hours to monitoring overdrafts (even though much of this is done electronically and based on some computer programmed algorithms, banks, to varying degrees depending on the extent to which they rely on these programs, still have to monitor daily overdrafts).
  • Banks incur less of a risk when taking on a new customer. With checking accounts, banks are taking a big risk when they open an account for someone because it is impossible to know for sure how well that customer would manage the account. With savings accounts and the "money order plus" account I advocate, there would still be some risk, but the risk would be much lower.
  • It would be easier for the underbanked and the unbanked to get accounts to meet their financial needs, even if they do not have good credit.
  • People who lack the aptitude to manage their money would have available another way to manage money that, while not as convenient as a checking account, would at least be better than relying on a merely plain jane savings account or incurring hundreds of dollars of overdraft charges.

There are possible objections to my plan, which I have not yet resolved:
  • Just giving banks the incentive to do something doesn't mean that they will. And I'm not sure if my incentives are strong enough for banks to take on the new project (maybe there's a way to make this compulsory upon being FDIC insured....I'm not sure if such a move is wise, but I don't wish to dismiss it out of hand).
  • Customers who have one of these accounts will have to give up a very real convenience, that is, being able to write checks whenever for any amount they want. In other words, they'd have to come into the bank (or use ATM's if there is a way to work that into the plan).

*By "overdraft fees," I mean fees charged for incurring an overdraft when a check is presented for which the account holder does not have enough money to pay. In practice, there are two such fees: returned check fees (when the bank refuses to pay an item for which its account holder hasn't enough money) and overdraft fees proper (when the bank pays check anyway, throwing the account holder's account into a negative balance). In the media, these fees are often lumped together with what is called "overdraft protection," a lumping that is both unfortunate and misleading. In the banks I worked at, "overdraft protection" meant only one of two things: 1) linking a line of credit to a checking about that would kick in in case a check is presented that the account would otherwise not have money to pay. In a sense, this is a small "credit card"-like loan. 2) linking a savings account to a checking account that would do the same thing as the aforementioned line of credit. There are usually fees involved in either of these approaches. One bank at which I have a checking account charges a small finance charge and $2.00 per advance. Another bank charges a small finance charge and also an annual fee ($10) that I'm more than happy to pay. Sometimes people start living off their overdraft protection when it is a credit line, sometimes also called "cash reserves," and that is a problem of consumer credit debt--something I am not addressing in this post--and not a problem of overdraft fees.
**I say "grudgingly" because customer service reps are usually penalized in some way for the number of fee waivers they assign. When I was a CSR, there was a list of the three highest fee waiver reps each month, and I was consistently on it. I was evidently good enough at my job that this did not affect my work evaluations too much, but in some cases it might have. After I had been working at this bank for about a year, it instituted a policy of not penalizing CSR's when they refund a fee that was incurred due to "bank error." Fair enough, but sometimes the definition of "bank error" was in dispute. For example, if someone's debit card had been stolen, it's not really the bank's fault and not necessarily the customer's fault either (unless the customer was careless, but even so, the fault is not pure), and these fee waivers were usually charged to the CSR.
***See, generally, my comment above in **. I will also add that the particular bank I worked for did a very good job, in my opinion, in treating its employees well and evaluating their employees on their overall performance and not merely by their ability to meet the call center's statistical goals. So, for example, they would monitor such items as amount of fees waived, amount of time spent taking calls as opposed to doing paper work (we were expected to spend 92% of our time taking calls), and our "talk time" (average amount of time spent on each call...the goal was 90 seconds per call). But the management also recognized when an employee spent a lot of time helping a customer that needed help, even when doing so hurt the official statistics by which they were supposed to judge employees. I think there were at least two reasons for this state of affairs at the bank: 1) the bank had a management plan that focused on maintaining its niche market as a medium sized bank in Colorado, and doing so required a workforce that was more stable than in larger, more nationally oriented banks (as an aside, while the bank was big in the Colorado market, it was not big enough, for example, to "export" its call center jobs to allegedly cheaper labor in, say, India....this assertion is a bit inaccurate, because it did farm out some of its credit card customer service, which operated a bit differently when it came to security measures taken by the bank, even though CSR's like me also did credit card customer service calls); 2) Colorado was blessed (or cursed, depending on who you are) with a labor shortage, making it hard to retain good workers in the service sector, which meant the bank had to work hard to retain its employees.
**** Already in practice, regular savings accounts at banks usually allow availability of funds based on the same regulations that apply to checking accounts. However, banks are not obliged to do so, and when they do, it is as a matter of practice and not as a matter of abrogating their prerogative not to do so. In theory, banks can deny customers access to their funds for a longer period of time (it may be up to 90 days, although I forget the exact number). These rules result (I think) from a federal reserve bank regulation ("Regulation D") that defines a savings account and from the reserve requirements that a bank must follow to be federally insured. In short, banks are permitted to keep lower reserves for the amount of funds they hold in savings than for the amount they hold in checking because they have more discretion in denying their availability to the customer. (I'm going a bit out on a limb here and speaking off the cuff, so I may be wrong on the specifics).

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