Why banks are getting rid of overdraft fees

The average overdraft fee costs consumers $35 per breach, making it an inconvenient and frustrating part of everyday banking for many people. But some big banks — Capital One, Bank of America, Truist, US Bank, and Wells Fargo — have recently taken steps to reduce or eliminate overdraft fees for their customers. In 2019, Discover also eliminated fees on all of its bank accounts, including overdraft fees, and Ally Bank eliminated overdraft fees in 2021.

According to Investigations by the Consumer Financial Protection Bureau, banks collectively earned more than $15 billion in overdraft fees in 2019, meaning individual banks could potentially be missing out on hundreds of millions of dollars by stopping charging overdraft fees. For example, Capital One’s move to eliminate overdraft fees will cost the company $150 million, according to a spokesman.

So what do the banks gain by eliminating these fees?

Why are banks eliminating or reducing overdraft fees?

“Overdraft fees are extremely unpopular with consumers, and consumers now have more choices,” said Leigh Phillips, CEO of fintech nonprofit SaverLife and chair of the Consumer Financial Protection Bureau’s Consumer Advisory Board. “They used to only have mainstream options like banks and credit unions, or ancillary services like payday loans. Now neobanks and challenger banks are creating services that work well for a variety of consumers.”

With the rise of these new, smaller banks, as well as online and mobile-first banking services, the banking industry had to find more ways to compete for new customers. Overdrafts can be stressful and expensive, and if a bank can help customers avoid these potentially significant fees, that bank could be more attractive to consumers.

“What we’ve found is that when we make these types of changes, our customers and potential customers take notice,” said a spokesman for Capital One. “We realized that while these policies are expensive in the short term, they pay off in the long run.”

Some financial institutions like Chime and SoFi have gone so far as to offer consumers a certain amount of money – similar to a line of credit – that they can tap into if they overdraw their accounts. These features are provided free of charge with qualifying account activity. For example, Chime’s SpotMe feature can give customers up to $200 to cover the cost of a transaction instead of overdrafts, and SoFi offers customers up to $50.

The current overdraft system

Overdraft fees often include more than just the one-time fee for overdrafting an account. Once in a while, A bank charges an overdraft fee multiple times a day if a customer continues to use their debit card without sufficient funds in their account, which can add up to hundreds of dollars. There may also be additional associated fees for having a negative current account balance, using an overdraft protection wire transfer service, or using an overdraft line of credit. Ultimately, consumers can be responsible for significant overdraft fees, making financial difficulties even more difficult.

“Some consumers get into a bad overdraft pattern, often because they made a mistake or didn’t receive the payment they expected,” says Phillips. “When they get paid back, a lot of that is used to pay off overdraft fees. It’s not sustainable, especially for people who are on the lower socioeconomic spectrum or don’t have a steady income, like people who work in the gig economy or have hourly jobs.”

When banks enforce overdraft fees, they have an opportunity to penalize people who are likely already facing financial difficulties. The coronavirus pandemic has highlighted this hardship as people have had to adjust to new ways of working and making ends meet. Therefore, the trend of banks getting rid of or reducing overdraft fees can be seen as a step forward for consumers who need help to improve their financial situation.

“By making changes to our overdraft and underfunding fee policies, we are offering our clients the ability to better manage their cash flow, correct course when needed, and support their growth and financial well-being,” said a spokesman for Capital One .

Getting rid of overdraft fees is good for consumers. Still, overdraft fees can be a relatively small source of income for a bank. For example, Capital One reported $3.1 billion in net income in the third quarter of 2021 alone. The $150 million that the company says it will lose to overdraft fees accounts for about 4.8% of its total net income for the quarter. Compared to full year sales, this percentage will drop dramatically.

How consumers can assess and avoid overdraft fees

Consumers struggling with strict overdraft policies at their current bank can do so look at banking products which do not have overdraft fees or give customers the option to turn them off, meaning a transaction will be declined if there are insufficient funds in the account. Consumers can also look for banks that warn customers when their balance is getting low.

Because excessive overdraft fees can get in the way of wealth accumulation, Phillips sees the trend for banks to eliminate them as a positive and inclusive step for more consumers to build and maintain their financial security.

“We’re in a time when people need to participate equally in the financial mainstream,” says Phillips.

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