NCPA - National Center for Policy Analysis

The Economics and Regulation of Bank Overdraft Protection

May 21, 2012

Instead of bouncing checks, many banks have instead offered overdraft protection, in which a bank advances funds to clear the check so that it is not returned.  Over time, access to overdraft protection has grown as automated overdraft protection has reduced its cost and risk and increased its scale, say Todd J. Zywicki, a professor of law at George Mason University School of Law, and Nick Tuszynski, a graduate research fellow at the Mercatus Center.

  • The Federal Deposit Insurance Corporation (FDIC) found in its 2006 survey of 1,171 FDIC-supervised banks that 86 percent of banks "operated at least one formal overdraft program" and that 40.5 percent of all banks offered automated overdraft programs.
  • Among banks with over $1 billion in assets, 76 percent offered automated overdraft programs.
  • In 2010, 13 million consumers used overdraft protection and banks generated $35 billion in revenue from this use, an important and growing part of total bank revenue.

The growth of this technique has drawn the attention of bank regulators, who have propagated regulations under the justification that they are concerned about harm to consumers.  However, consumers' continued insistence to participate suggests strongly that such a concern is unfounded.

  • One regional bank solicited opt-in for overdraft protection for debit card transactions from its largest overdraft users.
  • The bank sought permission from 499 customers that had 25 or more overdraft transactions in 2010.
  • Of the 499 customers, 466 (93 percent) opted in for debit card transactions and 33 (7 percent) opted out.
  • Overall, 73 percent of the bank's customers chose to opt-in to debit card overdraft protection.
  • Furthermore, according to a survey by Moebs, at various large banks 60 percent to 80 percent of customers opted-in to debit card overdraft protection, with a median opt-in rate of 75 percent.

Nevertheless, various entities have sought to limit the practice through regulations that make it difficult to operate for the bank and to participate in for the customer.

  • In 2009, the Federal Reserve required that consumers must affirmatively choose to opt-in to overdraft protection.
  • In 2010, the FDIC mandated that banks must "monitor [customer] accounts" and "take meaningful and effective action to limit use by customers" of overdraft protection.
  • In 2011, the Office of the Comptroller of the Currency required banks to conduct sufficient analysis to ensure that the customer will be able to manage and repay the credit obligations.

Source: Todd J. Zywicki and Nick Tuszynski, "The Economics and Regulation of Bank Overdraft Protection," Federalist Society, May 9, 2012.

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