Overdraft Fee Controversy Resurfaces: Congressional Hearing Focuses on Banking Windfall Profits, Community Banks' High Dependence Draws Attention

In May, two congressional hearings on Capitol Hill became a stage for Democratic and Republican lawmakers to confront the CEOs of major Wall Street banks. Some Republicans focused on voting rights and "wokeness," while several Democrats targeted overdraft fees—charges financial institutions impose when customers overdraw their accounts.

Senator Elizabeth Warren (D-Mass.) quickly labeled Jamie Dimon, CEO of JPMorgan Chase, the largest U.S. bank, as the "star of the overdraft fee show," noting the bank collected $1.5 billion in overdraft fees during the COVID-19 pandemic. A heated exchange followed, with Dimon calling Warren's data "completely inaccurate." But Warren did not back down, dismissing the bank's claims of increased customer assistance during the pandemic as "a bunch of nonsense" and pointing out that JPMorgan earned $27.6 billion in profit during record unemployment.

Although JPMorgan responded that it waived more than $430 million in overdraft fees at customer request between January 2020 and March 2021, Warren's criticism still put the bank in the spotlight—its overdraft fee revenue ranks first among U.S. banks.

While overdraft fees have made large banks targets of lawmakers' scrutiny, community banks were the most reliant on service fees as operating revenue last year. According to S&P Global data, two Texas-based banks—First National Bank Texas and Woodforest National Bank—derived more than 30% of their operating revenue from service fees in 2020. First National Bank in Killeen reported $100.3 million in overdraft fee revenue and $35.7 million in net income in 2020; Woodforest reported $142.4 million in overdraft fee revenue and $128.4 million in net income.

Aaron Klein, a Brookings Institution fellow and frequent critic of overdraft fees, calls such banks "check cashers with bank charters." In a March column, he wrote: "These entities are not banks in the traditional sense; they do not take deposits, make loans, or help customers and the economy. They are a combination of payday lending and check cashing, with a business model dependent on a single product with an astonishingly high annual percentage rate, paid only by people who run out of money."

Banking Dive reached out to First National Bank and Woodforest for comment but did not receive a response.

Shifting customer expectations

In recent months, large U.S. banks and regional institutions have moved to offer new products and services to help customers avoid overdraft fees, such as alerts, grace periods, or emergency credit lines. However, it remains unclear whether smaller banks that rely on overdraft fees as a revenue source can afford the same changes.

Although many stakeholders agree that banks should rethink the overdraft fee model, whether legislation or the market will ultimately drive this change remains to be seen.

Chris Williston, president and CEO of the Independent Bankers Association of Texas, said: "The market may be creating conditions where customer expectations shift toward alternatives to the traditional overdraft fee model. If the market drives a different model, that seems less arbitrary to me than government or think tanks trying to shut down a consumer product." The association's members include Woodforest and First National Bank.

Supporters of the model argue that consumers voluntarily choose overdraft protection to meet critical financial needs, such as buying gas, groceries, or paying a mortgage. David Pommerehn, senior vice president and general counsel of the Consumer Bankers Association (CBA), said: "Nearly half of Americans cannot handle a $400 emergency expense. Sometimes consumers need short-term liquidity or an emergency safety net, which is why well-regulated banks offer overdraft options."

According to a June survey by Morning Consult, customer opinions on the fairness of overdraft fees are divided. About 52% of U.S. adults believe overdraft fees are a disproportionate penalty that affects vulnerable consumers more; 48% believe they are a reasonable charge for banks when consumers overspend.

Williston believes banks are already responding to customer demand for overdraft alternatives—a shift partly driven by challenger banks, which have long advertised no overdraft fees and early access to direct deposits. San Francisco-based Chime's SpotMe feature allows customers to overdraw up to $200, while Varo Bank allows users to overdraw account balances by up to $50. Williston said: "These customer expectations could completely change the overdraft game. If these products become customer expectations, you have to step in. Otherwise, people will continue to flock to challenger banks."

But not everyone believes the market can solve the problem on its own and create more choices for customers. Rep. Carolyn Maloney (D-N.Y.), referring to the $8 billion in overdraft fees collected by large U.S. banks last year, said: "The numbers don't lie. Clearly, other options aren't working." She reintroduced the Overdraft Protection Act this month, a bill she has introduced in every Congress since 2009 but has not yet passed. Maloney expressed confidence the bill will pass in this Congress. The bill would prevent banks from charging customers more than one overdraft fee per calendar month and limit overdraft fees to six per year. It would also prohibit banks from processing transactions in ways that maximize overdraft fees, such as ordering from largest to smallest, forcing customers to overdraw more frequently. Additionally, the bill requires banks to disclose overdraft fee limits, opt-in policies, and alternatives to overdraft coverage.

But bank trade groups like the CBA say Maloney's bill would limit consumer choice. Pommerehn said: "Consumers have the right to choose products and services that best meet their daily financial needs. Policymakers should focus on encouraging innovation in a well-regulated and competitive banking sector, rather than stifling the choice and flexibility that overdraft services provide."

Beyond potential losses

Some banks are not waiting for Congress to mandate change. Frost Bank launched an overdraft grace feature in April, allowing customers to overdraw up to $100 on transactions. Columbus-based Huntington Bank launched Standby Cash last month, a digital-only lending product that gives eligible customers immediate access to a credit line of up to $1,000, with no interest or fees if they enroll in automatic payments. The bank began testing the product with community groups in several cities last summer. Without automatic payments, customers pay monthly interest of 1% on the outstanding balance. Huntington says customers are primarily qualified based on their checking account management rather than credit scores.

Huntington CEO Steve Steinour told Banking Dive last month that the bank could lose up to $1 million per month due to Standby Cash, but he hopes the product will attract more customers and build loyalty among existing ones. According to Morgan Stanley data, overdraft fees accounted for 2% of Huntington's 2020 revenue.

PNC has also revised its overdraft policy—CEO Bill Demchak said the change will reduce revenue by about $125 million to $150 million annually. PNC's new "Low Cash Mode" gives customers a 24-hour grace period when an account is negative to prevent or resolve overdrafts before a fee is charged.

Ally Bank went further last month, deciding to eliminate overdraft fees entirely after waiving them from March to July 2020. For Ally, the loss is relatively small. According to The Wall Street Journal, the bank collected $5 million in overdraft fees in 2020, just 0.07% of total revenue.

Maloney said that although she is encouraged by some traditional banks implementing products to help customers avoid overdraft fees, legislation is still necessary. She said: "It's hard for us to require banks to offer $1,000 credit lines. I think it's good that Huntington is doing this, but I think a better approach is to stop unfair, deceptive practices that push people into overdraft."

'Less reliable'

Banks are rethinking overdraft fees not only due to pressure from fintech companies and lawmakers, but also because revenue from the fees is declining. Financial data firm Moebs Services Inc. found that banks across the industry collected about $31.3 billion in overdraft fees in 2020, down from $34.6 billion in 2019.

Corey Stone, senior advisor at the Financial Health Network, said that for some consumers, extended unemployment benefits and stimulus payments during the pandemic meant fewer customers overdrawing their accounts. He said: "A once-reliable revenue source has become less reliable and may become dispensable in institutions that already rely on it less." He added that beyond the positive publicity from offering overdraft avoidance products, banks may also be responding to signs that future revenue from overdrafts will not be as high as today. Competition from challenger banks is one reason, and another may be what Stone calls the new "earned wage access" industry.

Stone said: "These overdraft prevention services, either offered through employers or by third-party fintech companies, access employer payroll data or bank account information to know when wages arrive, and then provide a portion of earned wages in advance, helping people avoid overdrafts." Neobanks like Chime, Varo Bank, and Current offer these services alongside no-overdraft-fee accounts. Traditional banks like Fifth Third and Capital One have also launched similar products.

Stone said: "I don't know to what extent earned wage access can help people avoid overdrafts in the long term, but I know these services claim to help customers avoid overdrafts. If banks can offer services that help people manage their money better, that's great. Overdrafts are expensive credit—high fees for small credit, and people who frequently overdraw often just overspend by a little. Helping them not overspend isn't hard." But he noted that banks' incentives are, of course, still to make money.

In a white paper published last year by Oliver Wyman titled "Beyond Overdrafts," Stone and co-authors Dennis Chira and Aaron Fine proposed that banks should design a solution consumers would be willing to pay $10 per month for. The authors wrote: "If you can bring in a new frequent overdrafter, get an existing occasional overdrafter to adopt the solution, and convert an existing frequent overdrafter, the math works. At $10 per month, a typical bank could convert all its frequent overdrafters to a no-overdraft-fee plan and break even by acquiring just one new frequent overdrafter and converting one existing occasional overdrafter."

Melissa Gopnik, senior vice president at Commonwealth, a nonprofit focused on the financial security of vulnerable populations, said some banks are shifting their focus to customers' financial health. She said: "Overdraft fees generate significant revenue for financial institutions, but not in a way that promotes customer financial health. I think this shows a real shift in the financial industry, from seeing itself as processing transactions, ensuring deposits and withdrawals happen, and ensuring details are correct, to thinking more about customers' financial health."

Third-party solutions?

Joel Schwartz, a former banker at First Bank in St. Louis, has witnessed and frequently felt consumer dissatisfaction with overdraft fees. He said: "My customers came in every day angry and frustrated, saying 'Why aren't you helping me with my account?' Our CEO said we need these fees, and of course regulators said it was completely out of control. I knew there had to be a better way for all parties to win." That experience led him to found fintech company DoubleCheck Solutions, which works with banks looking to move away from overdraft fee charges.

DoubleCheck notifies customers in real time when their account balance is insufficient, allowing them to use multiple payment methods to change the bank's decision on which payments to cover. Schwartz said: "The most important thing is control." Customers of banks and credit unions that work with DoubleCheck automatically receive its service when they overdraw. DoubleCheck notifies customers via text, email, or optional robocall and offers multiple options. After verification, customers see the full payment picture—which items are being paid, which are returned, and which are covered by overdraft. Customers can choose to change the bank's payment decision, cover the deficit with a credit card or third party, or do nothing. Schwartz said the technology allows customers to make decisions in real time, rather than relying on decisions made at account opening to opt in or out of overdraft protection services.

DoubleCheck charges financial institutions an integration fee to launch the platform, but most of its revenue comes from transaction fees charged to customers. Schwartz said DoubleCheck shares fee revenue with financial institutions, with pricing set by the institutions. The company says it has six clients signed up, all at different stages of integration.

Schwartz believes banks need to change how they handle overdrafts but does not think the service should be eliminated entirely. He said: "Eliminating overdrafts entirely could worsen the problem. Without overdrafts, we'd have to return all transactions. But what if that's my mortgage or my child's tuition?" DoubleCheck's service also applies to small businesses. He said: "Many small businesses, especially after the pandemic, need to manage cash flow, and they need other tools to stay operational."