WikiLeaks Document Release
http://wikileaks.org/wiki/CRS-RS22874
February 2, 2009
Congressional Research Service
Report RS22874
Overdraft/Bounced-Check Protection
Pauline Smale, Government and Finance Division
May 13, 2008
Abstract. Overdraft protection programs are an option offered by financial institutions to consumers. These
programs are often referred to as "bounced-check protection" or "courtesy overdraft protection" to distinguish
them from the more traditional overdraft lines of credit. Participating institutions cover checks drawn on
accounts with insufficient funds and charge a fee. Financial institution representatives state that these programs
offer a beneficial service to their customers by covering checks that would otherwise be returned unpaid.
Consumer advocates argue that these programs are highcost credit products that are marketed to vulnerable
consumers, and that their main purpose is to increase fee income for banks. In February 2005, federal regulators
of the banking industry issued guidance concerning bounced-check/overdraft protection services offered by
insured depository institutions. In May 2005, the Federal Reserve issued a final rule amending its Regulation
DD to address concerns about the adequacy and uniformity of consumer disclosures relating to overdraft services
offered by depository institutions, including the advertising of these services. Legislation in the 110th Congress
(H.R. 946) would define these overdrafts as short-term extensions of credit and would provide enhanced consumer
protections. On May 2, 2008, ongoing concerns with and interest in overdraft services prompted federal banking
regulators to issue additional proposed rules to enhance consumer protections.
Order Code RS22874
May 13, 2008
Overdraft/Bounced-Check Protection
Pauline Smale
Economic Analyst
Government and Finance Division
Summary
Overdraft protection programs are an option offered by financial institutions to
consumers. These programs are often referred to as "bounced-check protection" or
http://wikileaks.org/wiki/CRS-RS22874
"courtesy overdraft protection" to distinguish them from the more traditional overdraft
lines of credit. Participating institutions cover checks drawn on accounts with
insufficient funds and charge a fee. Financial institution representatives state that these
programs offer a beneficial service to their customers by covering checks that would
otherwise be returned unpaid. Consumer advocates argue that these programs are high-
cost credit products that are marketed to vulnerable consumers, and that their main
purpose is to increase fee income for banks. In February 2005, federal regulators of the
banking industry issued guidance concerning bounced-check/overdraft protection
services offered by insured depository institutions. In May 2005, the Federal Reserve
issued a final rule amending its Regulation DD to address concerns about the adequacy
and uniformity of consumer disclosures relating to overdraft services offered by
depository institutions, including the advertising of these services. Legislation in the
110th Congress (H.R. 946) would define these overdrafts as short-term extensions of
credit and would provide enhanced consumer protections. On May 2, 2008, ongoing
concerns with and interest in overdraft services prompted federal banking regulators to
issue additional proposed rules to enhance consumer protections. This report will be
updated as events and legislation warrant.
Background
Traditionally, when a bank customer writes a check on an account that does not have
sufficient funds on deposit to cover the amount of the check, he or she is charged a
nonsufficient-funds (NSF) fee as a penalty. The check would be returned unpaid to the
merchant or other third party. The customer could be charged another fee by that third
party. The management of a financial institution does have the discretion to cover the
overdraft (not return the check) and charge an overdraft fee. Consumers can often make
an arrangement with their bank for an overdraft to be covered by funds held in another
account the consumer holds with the institution (for example a savings account).
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Financial institutions have offered overdraft lines of credit for protection against
account overdrafts. A customer must apply for this credit product and meet
creditworthiness criteria set by the institution. The lines of credit are subject to the
disclosure requirements of the Truth in Lending Act1 implemented by Federal Reserve
Regulation Z. Lines of credit usually charge an annual interest rate (generally around
18% to 20%) and allow repayment as the customer chooses within the terms of their
agreement with the institution.
A more recent option for consumers is the bounced-check protection or courtesy
overdraft protection service. These services vary among institutions but most share basic
terms and conditions. Participating institutions offer this type of overdraft protection as
a feature of their accounts, and customers do not have to apply and qualify for the service.
An account normally qualifies if it has been open for a specified period and if there are
regular deposits to the account. A ceiling is set for overdraft coverage, usually between
$100 and $500. A flat fee (generally the bank's standard NSF fee) is charged each time
an overdraft item is covered, and a daily fee may be charged for each day the account
remains overdrawn. The service may extend beyond check transactions to other
transactions including withdrawals at automated teller machines (ATMs), on-line
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banking, and debit card point of sale transactions. A specified time period may be set for
overdraft repayment. Some institutions offer closed-end loans to customers who cannot
meet the repayment deadline. Many programs are offered with the caveat that payment
of an overdraft is discretionary on the part of the institution and, therefore, they may not
pay all the overdrafts that customers incur. Some institutions employ automated systems
to handle overdraft accommodations.
2005 Federal Regulatory Response
Guidance issued by federal regulators. In February 2005, guidance was
issued by federal regulators addressing the risks presented by bounced-check or courtesy
overdraft protection services. The guidance also incorporated a best practices list to assist
financial institutions in developing responsible disclosure and program administration
policies. The guidance was issued to assist depository institutions in the disclosure and
administration of overdraft programs. In general, failure to comply with regulatory
guidance may cause regulatory concern that a financial institution is not adequately
protecting itself against risk. Two guidance documents were issued; the documents are
similar but not identical. On February 14, 2005, the Office of Thrift Institutions issued
guidance separately.2 On February 18, 2005, joint guidance was issued by the Office of
the Comptroller of the Currency, the Board of Governors of the Federal Reserve System,
the Federal Deposit Insurance Corporation, and the National Credit Union
Administration.3 The guidance documents reviewed the safety and soundness concerns
raised by bounced-check or courtesy overdraft protection services, and stated that
1
15 U.S.C. 1601.
2
The press release and access to the guidance document can be found at
[http://www.ots.treas.gov/docs/7/77503.html].
3
The press release and access to the joint guidance can be found at
[http://www.fdic.gov/news/news/press/2005/fil1105.html].
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institutions should adopt written policies and procedures to address operational and other
risks associated with overdraft programs. The joint agency guidance included an overview
of legal risks. Both guidance documents informed institutions purchasing automated
bounced-check protection programs from third-party vendors that a due diligence review
should be conducted prior to entering into a contract.
Both documents stated that clear disclosures and explanations to consumers of the
operation, costs, and limitations of an institution's overdraft program are essential. The
guidance highlighted examples of disclosure and marketing practices that raised concern.
For instance, some institutions did not clearly illustrate all the types of transactions (ATM
withdrawals, debit card purchases, telephone transfers) besides checks that may be
covered by overdraft protections. Some marketing practices appeared to encourage
consumers to overdraw their accounts by using the service to meet short-term credit
needs. Some institutions did not clearly distinguish how the bounced-check or courtesy
overdraft service differed from a traditional line of credit. Other institutions included
overdraft protection amounts in the sum they disclosed as the consumer's account
"balance" without clearly distinguishing the funds that are available for withdrawal
without overdrawing the account.
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The guidance provided a best practices list to be taken into consideration by
institutions with (or those establishing) bounced-check/overdraft protection programs.
The list was divided into two categories: (1) marketing and communications with
consumers, and (2) program features and operation. Included were clear disclosure of
program fees and an opt-out feature. The Office of Thrift Supervision added a best
practice: to not manipulate transaction clearing rules to inflate fees.
Amendments to Regulation DD. The Board of Governors of the Federal
Reserve System began to study bounced-check and courtesy overdraft services in 2002
to determine the need for regulatory guidance and/or revisions to Board Regulations. The
Board solicited public comment and information on the issues. On May 19, 2005, the
Federal Reserve issued a final rule amending its Regulation DD to provide consumers
with uniform and adequate disclosure information concerning bounced-check or courtesy
overdraft protection services.4 Regulation DD implements the Truth in Savings Act
(TISA),5 which requires depository institutions to provide disclosures to enable
consumers to make meaningful comparisons of deposit accounts. Regulation DD also
contains rules for advertising deposit accounts. The Board stated that the revisions to
Regulation DD are consistent with the joint guidance issued previously by Board and
other regulators. Compliance with the amendments to Regulation DD became mandatory
on July 1, 2006. Compliance is enforced by the appropriate federal banking agency;
failure to comply can result in administrative sanctions.
The Board chose to amend Regulation DD because "an overdraft service is
provided as a feature and term of a deposit account, and that the fees associated with the
4
The press release and access to the final rule can be found at
[http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20050519/default.htm].
5
12 U.S.C. 4301.
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service are assessed against the deposit account."6 The Board stated that the adoption of
these amendments did not rule out a possible future determination that Regulation Z
(Truth in Lending) disclosures would be appropriate.
The amendments to Regulation DD addressed account-opening disclosures,
periodic statement disclosures, and advertising rules. Institutions must now include in the
account opening disclosures required by the TISA the categories of transactions for which
an overdraft fee may be imposed. Examples of categories include checks, in person
withdrawals, and electronic withdrawals.
New periodic account statement disclosures are required for institutions that
promote the payment of overdrafts in an advertisement. The added information fields are
the total amount of fees or charges imposed on the account for paying overdrafts and the
total amount of fees charged for returning items unpaid. The added disclosures must be
provided for both the statement period and for the calendar year to date. Communications
that are defined as advertisements, as well as those that are excluded from the definition,
are described in detail. The advertising requirement is also triggered if the periodic
statement includes a message stating the overdraft limit for an account; or by disclosing
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an overdraft limit or including the amount of that limit in an account balance presented
on an ATM receipt, an ATM screen, an institution's Internet site, or telephone response
system.
The Regulation DD revisions include changes to advertising rules. Bounced-
check/overdraft protection advertisements must include the applicable fees or charges, the
categories of transactions covered, the time period consumers have to repay or cover any
overdraft, and the circumstances under which the institution would not pay an overdraft.
Specific situations where some or all of the added disclosures are not required are
covered. In addition, advertisements that are misleading or that misrepresent the overdraft
service are prohibited. Specific examples of what is prohibited are provided.
Legislation and Ongoing Concerns
Bounced-Check/Overdraft Protection Legislation. The Consumer
Overdraft Protection Fair Practices Act (H.R. 946), was introduced on February 8, 2007
by Representative Carolyn B. Maloney and others, and referred to the House Committee
on Financial Services. The legislation would define overdrafts as short term extensions
of credit, extend the protections of the Truth in Lending Act (TILA) to bounced-
check/overdraft protection programs, and provide for other consumer protections. On
July 11, 2007, hearings were held by the Subcommittee on Financial Institutions and
Consumer Credit of the House Committee on Financial Services.7 The legislation would
define overdraft protection programs or services as short-term extensions of credit. The
legislation would amend TILA (implemented by Federal Reserve Regulation Z) to extend
6
Truth in Savings: Final Rule, issued May 19, 2005, p. 8, available at
[http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20050519/default.htm].
7
Testimony presented at the hearings can be found on the committee's website
[http://www.house.gov/apps/list/hearing/financialsvcs_dem/hr0705072.shtml].
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its coverage to these programs. Fees associated with overdraft protection programs (if
imposed more than three times a year) would be considered finance charges and must be
disclosed as both a dollar amount and in terms of an annual percentage rate (APR). The
legislation would provide for additional restrictions specific to overdraft protection
programs and services. Before a depository institution could initiate a bounced-
check/overdraft service, an account holder would have to provide written consent to an
agreement detailing the terms and conditions of the service (an opt-in feature as opposed
to an opt-out). The legislation addresses restrictions on the advertising of overdraft
programs. The restrictions would include a prohibition on advertisements that are
misleading or that misrepresent the overdraft protections or services.
H.R. 946 would also require depository financial institutions to warn customers
at electronic terminals that a requested electronic fund transfer would trigger an overdraft
protection fee and permit the customer to cancel the transaction. Additionally, the bill
would prohibit institutions from manipulating the process of posting checks and debits
against an account to increase the account holder's overdraft fees.
Industry Response to H.R. 946. At the hearings, industry representatives
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expressed general opposition to H.R 946. It was stated that the recent actions taken by
federal banking regulators concerning bounced- check/overdraft programs were providing
consumers with adequate disclosure and protection. It was argued that the additional
TILA disclosure requirements and program restrictions required by the legislation would
impose considerable costs and would likely result in the discontinuance of this beneficial
service for many consumers. Transmitting the notifications required by the legislation at
electronic terminals would necessitate potentially prohibitive technical changes to the
terminals and software. Financial institutions have worked to make it easier for a
consumer to check an account balance online or by telephone but providing "real time"
account balance information presents difficult challenges. Industry representatives argue
that the consumer is in the best position to know if authorized but possibly not yet
processed (cleared) transactions would change the balance provided by the bank. If an
account holder carefully keeps track of all their transactions (including checks, debit card
purchases, and preauthorized automated payments), they have the best information to
avoid overdrafts.
Consumer Advocate Response to H.R. 946. The hearings' testimony from
consumer advocates was supportive of H.R. 946 stating that the legislation would provide
many of the protections they have sought. The general belief is that financial institutions
have transformed a beneficial, occasionally employed back-up system for consumer
checking accounts into an automated system that triggers high cost bank overdraft loans.
Direct deposit, electronic payments, and advances in technology have made it more
difficult for consumers to track their account balance to avoid overdrafts. Consumer
advocates have urged the Federal Reserve to revise its Regulation Z, which implements
the Truth in Lending Act, to require institutions to treat courtesy overdrafts as loans. The
TILA disclosures required by H.R. 946 would enable consumers to make more informed
decisions and would require consumers to actively choose to participate in bounced-
check/overdraft protection programs by signing up (opting-in). Warning notifications at
electronic terminals would prevent unintentional overdrafts.
Proposed Enhanced Protections. On May 2, 2008, the Board of Governors
of the Federal Reserve System, the National Credit Union Administration, and the Office
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of Thrift Institutions (working jointly) proposed rules to address ongoing concerns with
aspects of the marketing, disclosure, and implementation of overdraft services. The
banking regulators stated that concerns with overdraft services continue despite the
issuance of the 2005 guidance and Regulation DD amendments. The banking regulators
used their statutory authority to address unfair or deceptive practices provided by the
Federal Trade Commission Act.8 The Federal Reserve also proposed complementary
additional amendments to Regulation DD.9
The enhanced protections include a substantive opt-out notice requirement for
bounced-check/overdraft services. The proposal would require that consumers receive
an opt-out notice before a financial institution assesses any fees in connection with paying
an overdraft, the proposal sets forth content and timing requirements. In addition,
consumers would be able to choose the option of a partial opt-out, for example, by
directing their institution to pay overdrafts resulting from checks but opting out of
overdraft services for ATM and debit card transactions.
The proposal would require all institutions to provide aggregate cost information
for overdraft services on periodic statements to facilitate the consumer's ability to make
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informed judgements about using these services. Currently, periodic account statement
disclosures are required for institutions that promote the payment of overdrafts in an
advertisement.
When account balance information is provided in response to a consumer inquiry
(including those made at electronic terminals) this proposal would prohibit financial
institutions from including in the disclosed balance any additional amounts of funds that
may be provided to cover an overdraft. Generally institutions would disclose only the
amount of funds available for immediate use. The institution would not be required to
provide "real-time" balance disclosures.
Finally, financial institutions would be prohibited from charging an overdraft fee
if the overdraft results solely from a "debit hold" amount placed on an account which
exceeds the actual cost of the purchase.
8
15 U.S.C. 41-58.
9
Detailed information on the statutory authority provided by the FTC Act, the proposed rules,
and proposed Regulation DD changes can be found at
[http://www.federalreserve.gov/newsevents/press/bcreg/20080502a.htm].