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Abolish bank overdraft fees that prey on people who can least afford them

The federal government has been lax about regulating bank practices that mostly target people who live paycheck to paycheck.

The Ally Detroit Center, headquarters of Ally Financial Inc., in downtown Detroit in 2014. Ally Financial is ending overdraft fees entirely on all of its bank products, the company has said.
The Ally Detroit Center, headquarters of Ally Financial Inc., in downtown Detroit in 2014. Ally Financial is ending overdraft fees entirely on all of its bank products, the company said this week.
Tanya Moutzalias/Ann Arbor News via AP

At a time when even some libraries are dispensing with late fees for books, what makes banks think it’s a good idea to saddle hefty overdraft fees on those least able to pay them?

Why do banks think people living paycheck to paycheck should pay $38 for a cup of coffee — $3 for the coffee and $35 for an onerous overdraft fee?

Yet that is what many banks do through pernicious overdraft fees. Ninety-five percent of those hit by overdraft fees in 2020 were financially vulnerable and disproportionately Black and Latino, according to a 2021 FinHealth Spend Report. In effect, the people least able to pay are subsidizing banking services for those who can afford to park enough money in their accounts to assure they won’t be hit by fees. Federal regulators, missing in action, should step in and fix this.

Some banks cut back on the hated overdraft fees during the pandemic, but there’s no guarantee they won’t return to business as usual.

In a piece of good news, Detroit-based Ally Financial, a digital-only bank, announced this week that it would stop charging overdraft fees permanently on all its bank products, something it had started doing during the pandemic. Ally Financial was the first large U.S. bank to do so. Other banks should follow suit. Overdraft fees are essentially very short loans that can have an effective interest rate of more than 1,000%. Even the most shameless loan sharks don’t get that kind of vig.

Last week, Sen. Elizabeth Warren, D-Mass, told the Senate Banking Committee that Bank of America, JPMorgan Chase, Citigroup and Wells Fargo squeezed their customers for a combined $4 billion in overdraft fees and that low-income people paid most of the fines. That didn’t include regional banks, whose bottom lines are more dependent on the fees, according to a Morgan Stanley report released Tuesday.

But if a smaller bank like Ally “can step up and automatically waive overdraft fees for its customers,” as Warren tweeted on Wednesday, “so can the giant banks.”

The fees can be financially devastating because they are levied on every transaction once an account is overdrawn. Before customers realize their accounts are short, they might make numerous small charges, running up fees that can total hundreds of dollars. Some banks make matters worse by “reordering” charges and deposits to maximize the amount of the fees. In 2019, banks made about $12 billion from overdraft and insufficient fund fees, according to the Center for Responsible Lending. Such practices discourage many people from opening accounts, leaving them “unbanked.”

Banks really need to rethink this.

If banks were to abolish overdraft fees, “the majority of customers would not be impacted, but the most vulnerable segment would be,” Lamont Black, a DePaul University associate professor of finance and real estate, and a former economist at the Federal Reserve in Washington, told us. “Rather than try to squeeze as much profit out of that group as they can, some banks are becoming more socially responsible.”

The average debit charge is $25, but the overdraft fee is as high as $35. Banks make most of their overdraft money from people who have an average of $350 in their checking accounts. Banks deserve to make a fair profit, of course, but they should do so in a way that spreads the costs among customers more evenly and fairly.

Over the years, the federal government has made some effort to address the problem but for the most part has dropped the ball, says Rebecca Borné, senior policy counsel at the Center for Responsible Lending.

And banks have aggressively managed to get people to agree to overdraft fees by such tactics as adding a pre-checked form to those that a customer signs when opening an account or portraying the fees as a free service. And the rule doesn’t apply to automatic debits or paper checks.

About 15 years ago, many banks started showing customers balances that were inflated by $1,000, hoping they would believe the higher number and overdraw their accounts, which many did only to find they were socked with numerous fees. In truth that $1,000 was just the so-called overdraft “protection” — what the bank would cover in exchange for those loan shark fees. The Federal Reserve stepped in to stop that practice, but federal regulators have been too lax since then, Borné said.

“What we have really needed for a long time is a rule that gets at fundamental abuses, including the size of the [overdraft] fee, which incentivizes a lot of mischief,” Borné said.

A $3 cup of coffee should cost $3, not $38. If banks can’t understand that, the federal government should explain it to them.

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