Overdraft Fees Are Getting a Much-Needed Overhaul

Overdraft fees have been a significant source of noninterest income for the banking industry since they were first introduced in the 1990s. But these “deterrent” fees are on the chopping block at major financial institutions across the country, putting pressure on smaller banks to follow suit.

Overdraft and non-sufficient funds (NSF) fees brought in an estimated $11 billion in revenue in 2021, according to the Financial Health Network, significantly down from $15.5 billion in fee revenue in 2019. As the industry responds to ongoing regulatory pressure on top of increased competition from neobanks and disruptive fintechs, that downward trend is expected to continue.

For larger banks, those with more than $10 billion in assets, overdraft fee income has trended downward since 2015. Christopher Marinac, director of research at Janney Montgomery Scott, reported on this back in December 2021 after noting overdraft fees had declined for 23 quarters and expects this trend to continue into 2022. Despite the decline, regulators continue to focus on them, citing their role in the growth of wealth inequality.

“[R]egulators have clearly sent a signal that they want those fees to either go away or be less emphasized,” Marinac says. “Like a lot of things in the regulatory world, this has been an area of focus and banks are going to find a way to make money elsewhere.”

For an industry that has evolved so rapidly over the last 10 years, overdraft fees represent a legacy banking service that has not adapted to today’s digital banking customer or the realistic cost to service this feature, says Darryl Knopp, senior director of portfolio marketing at the credit rating agency FICO. Knopp believes that an activities-based cost analysis would show just how mispriced these services actually are. It’s one reason why neobanks such as Chime have attracted customers boasting of lower fees. If banks were to think about overdrafts as access to short-term credit, that would change the pricing conversation to one of risk management.

“Banks are way more efficient than they were 30 years ago, and they need to understand what the actual costs of these services are,” Knopp says. “The pricing has not changed since I got into banking, and that’s why [banks] are getting lapped by the fintechs.”

Overdrafts aren’t going to disappear overnight, but some banks are getting ahead of the trend and taking action. Bank of America Corp., Wells Fargo & Co., and JPMorgan Chase & Co., which together brought in an estimated $2.8 billion in overdraft and NSF fee revenue in the first three quarters of 2021, recently announced reduced fees and implemented new grace periods, according to the Consumer Financial Protection Bureau. Capital One Financial Corp. announced the elimination of both overdraft and NSF fees back in December and Citigroup’s Citibank recently announced plans to eliminate overdraft fees, returned item fees, and overdraft protection fees.

In April, $4.2 billion First Internet Bancorp of Fishers, Indiana, announced the removal of overdraft fees on personal and small business deposit accounts, but it continues to charge NSF fees when applicable. Nicole Lorch, president and chief operating officer at First Internet Bank, talked to Bank Director’s Vice President of Research Emily McCormick about the decision to make this change. She says overdrafts were not a key source of income for the bank and the executives wanted to emphasize their customer-centric approach to service. First Internet Bank’s internal data also found that overdraft fees tended toward accidental oversight by the customers, whereas NSF fees were more often the result of egregious behavior.

“In the case of overdrafts,” says Lorch, “it felt like consumers could get themselves into the situation unintentionally, and we are not in this work to create hurdles for our customers.”

For banks that are grappling with the increased pressure to tackle this issue, there are other ways to get creative with overdraft and NSF fees. Last year, PNC Financial Services Group introduced its new “Low Cash Mode” offering, which comes with the Spend account inside of PNC’s Virtual Wallet. Low Cash Mode alerts customers to a low balance in their account. It gives customers the flexibility to choose which debits get processed, and provides a grace period of 24 hours or more to address an overdraft before charging a fee.

Banks that want to keep pace with the industry and are willing to take a proactive approach need to find ways to offer more personalized solutions.

“The problem is not the overdraft fee,” says Ron Shevlin, chief research officer at Cornerstone Advisors. “It’s a liquidity management problem and it’s bigger than just overdrawing one’s account. Banks should see this as an opportunity to help customers with their specific liquidity management needs.”

He says it’s time for the industry to move away from viewing overdrafts as a product and start thinking of it as a solutions-based service that can be personalized to a customer’s unique needs.

• Bank Director Vice President of Research Emily McCormick contributed to this report.