Opinion | Overdraft Fees Are Big Money for Small Banks

Once upon a time, if you tried swiping your debit card to buy something and your bank account was empty what happened was simple: Nothing. The register denied your payment. This happened all the time, particularly to Americans living paycheck-to-paycheck.

Then banks figured out that they could cover the overdraft for their customers with little risk and charge quite a lot for the service. It is hard for people to keep track of just how much is in their bank account, particularly since deposits including direct deposits can take days to post to the account.

Overdraft fees can be high, often $35, sometimes charged for each swipe of your debit card when you are out of money. This fee has become big money for banks, generating more than $31 billion in revenues in 2020. It has also become a major cost for tens of millions of families: One out of eleven Americans spends $350 or more a year in overdraft fees. Overdraft is one of many reasons why it is expensive to be poor in America.

Overdrafts are bigger business for some banks than others. JPMorgan Chase collected the most of any bank, more than $2 billion in 2019, which works out to more than $35 in overdraft fees per account. Sen. Elizabeth Warren (D-Mass.) called JPMorgan Chase CEO Jamie Dimon “star of the overdraft show” at a recent Senate hearing. Even when compared to other big banks, JPMorgan Chase earns a lot more in overdraft; Citibank, by contrast, averaged just over $5 per account.

But stopping the analysis with the largest banks misses an important reality: A handful of smaller banks are the true overdraft giants.

I began researching bank overdraft fees several years ago in an effort to understand how our slow system for processing payments affects lower-income earners and how it contributes to the bottom line of different financial institutions. My research uncovered that a small number of small banks make almost all their profit thanks to overdraft. These banks are running a business model more akin to a check casher than a bank.

According to my calculations, for multiple years running, at least six small banks depend on overdraft revenue for a majority of their profits. For three of those banks, overdraft revenues have exceeded total profits for each of the past two years — meaning these banks lost money from banking, except for charging overdraft fees.

For the largest banks, overdraft is a lot of money in aggregate, but a small share of their total profit. Even for JPMorgan Chase, overdraft revenue amounted to 7 percent of total profit; for Bank of America it was 6 percent; and for Citibank it was less than 1 percent.

Tiny Woodforest National Bank, on the other hand, which has only 5 percent as many customers as Citibank, manages to generate much more revenue in overdraft fees — an astonishing $135 per account, almost 24 times as much as Citibank and almost 4 times as much as JPMorgan Chase.

Why do some banks generate so much more in overdraft revenue than others? It’s well known that a small number of consumers account for the vast amount of overdrafts; 8 percent of bank customers account for almost 75 percent of all overdraft revenue, according to the Consumer Financial Protection Bureau. Targeting those specific users would seem to be the business model for Woodforest and others. Woodforest locates most of its branches at discount stores like Walmart. Armed Forces Bank averages $152 in overdraft fees per account, in part by targeting lower-income, enlisted military personnel as customers; financial stress is listed more frequently than any other family issue by veterans and military spouses among major causes of stress.

Differences in customer base seem unlikely to explain what is going on among the largest banks, however. It is hard to see how JPMorgan Chase’s customer base (over 60 million deposit accounts) would vary significantly from Bank of America (almost 113 million). Here the more likely reason for the banks’ differing dependency on overdraft fees has to do with the type of accounts being offered, how they are promoted and other bank-specific overdraft policies.

Why does Citibank generate so much less overdraft revenue than other big banks? One reason is that Citibank does not allow overdrafts at ATMs; customers are told they don’t have sufficient funds in their account. Citibank also aggressively promotes bank accounts that do not allow for overdraft. These accounts, which meet the general criteria outlined by the Cities for Financial Empowerment Fund’s “Bank On” certification system for low-cost no-overdraft bank accounts, are estimated to comprise 1 of every 5 new accounts at Citibank. In other words, a bank’s business decisions make a big difference in whether customers pay hefty overdraft fees.

Defending his institution, Dimon stated that JPMorgan Chase waived some overdraft fees to consumers during the Covid-19 pandemic. That helps explain why bank overdraft revenue dropped across the industry in 2020, falling by nearly 50 percent. This decline surprised many (including me), as the Covid recession devastated millions of families.

But there likely is more than bank fee waivers going on. Federal relief (such as Covid stimulus payments and enhanced unemployment insurance), decreases in expenses from remote work (like parking and dry cleaning) and increased certainty in expenses combined with control over the timing (eating at home versus eating out) could have all played a role in reducing overdrafts last year. But absent major change, there’s no reason to think that the amount of overdraft fees charged to consumers will not continue to rise.

It is ludicrous to have a banking system where people living on the financial edge pay high fees that de facto subsidize “free checking” for those who always have $1,000 or so to maintain a minimum balance. Banks are chartered by the government because they serve a public function and agree to abide by certain rules as a result. Our banking system should work to help people accumulate wealth and personal financial stability, not erode it.

How can we fix this and put the overdraft genie back in the bottle? Industry is taking some important steps. Wells Fargo announced a new initiative to increase awareness about its Bank On accounts, while PNC unveiled a sophisticated new tool designed to allow consumers to reduce their likelihood of overdrafting and, importantly, give customers a grace period of 24 hours to bring their account back above zero. Ally bank has announced it was eliminating overdraft altogether. The American Bankers Association recently urged all banks to offer Bank On accounts as a best practice. A paper coauthored by the largest banking and credit union trade associations also found that “the Bank On program has achieved remarkable success.”

Congress and bank regulators should turn these best practices into a requirement: All banks should be required to offer a low cost, no overdraft account to any consumer who wants one. These accounts can be profitable for banks, as Citibank demonstrates, and frankly, they should be considered a requirement for any publicly chartered institution.

Credit unions should also be required to do the same. Credit unions are supposed to be nonprofits focused on their members, but little is known about credit union overdraft practices, since they are exempt from reporting overdraft data. Many credit unions have been sued with allegations of abusive overdraft practices, and absent public data, it’s impossible to know just how good or bad their practices are.

The larger problem, of course, is that bank regulators have done nothing about this problem for a long time.

The Office of the Comptroller of the Currency regulates both the largest national banks and most of the smaller overdraft giants I’ve uncovered in my research. The OCC has continually allowed banks that are dependent on overdraft fees for a majority of their profits to be given passing regulatory grades. Instead, the OCC should put those banks on strict regulatory lockdown to reform their ways or be put out of business. The Federal Reserve, FDIC and National Credit Union Administration need to crack down on institutions they regulate who behave similarly. Because banks with assets under $2 billions are not required to disclose how much they collect in overdraft fees, no one knows the full depth of this problem. Regulators should require all banks and credit unions to disclose this data.

One of the many problems the 2008 financial crisis exposed was that bank regulators were willing to put bank profits above consumer protection. In the wake of that crisis, bank regulators promised they would change their ways and Congress agreed, allowing them to keep certain consumer protection responsibilities in their purview instead of transferring them to the CFPB.

It’s time for banks to stop assessing overdraft fees in a predatory manner, and it’s time for regulators to step up and make sure that happens. It’s no longer acceptable to permit some banks and credit unions to feed from the bottom with business models dependent on profiting from fees charged only to vulnerable Americans.