What Will Fewer Overdraft Fees Mean?

A few weeks back, Derek wrote a post about JP Morgan's and Bank of America's new overdraft rules. They will allow customers to opt out of being able to withdraw more than is in their checking account and not incur the fees that result. Fees for overdraft will also generally be lower. Since banks tend to follow one another, others will likely change their overdraft practices as well. Derek commented that this is excellent news for consumers. I think that's partially right: it's excellent news for some consumers. If you pay attention to the money in your checking account, and never would have attempted to draw more than you have, then it won't help you at all. In fact, when you think about it, these new rules might actually make checking more expensive for most consumers.

First, what caused banks to suddenly decide to reverse course in charging high overdraft fees? Bad publicity. Derek also wrote a post about overdrafts back in August commenting on the staggering amount overdraft fees banks collect each year. According to the Center for Responsible Lending, in 2008 U.S. banks collected $34.3 billion in fees on overdrawn accounts, $23.7 billion of which were overdraft fees alone.

Clearly, that's a lot of money. Much of that income will be eliminated with the new overdraft rules. So anyone who thinks that will just result in banks shrugging, and figuring they'll just make less money going forward raise your hands. I hope no hands are up.

If we've learned anything from last spring's credit card regulations, it's that banks intend to continue making money one way or another. Since their flexibility in changing interest rates were constrained, they've raised interest rates more broadly. Everyone is paying more now, instead of just those who the companies believed might pose more risk.

Similarly, banks don't want to lose the money they used to make from overdraft fees. After all, they need this money: those fees have been a major source or revenue for them. In reality beyond such fees, banks make very little off of their deposits. According to the FDIC's most recent quarterly banking profile (open .pdf), the spread between what banks charge for loans versus interest they pay on deposits, their profit margin, is just 3.48%.

So how much more in deposits would they need to make up for no more overdraft fees? Well, using that $34.3 billion figure and a Financial Times article estimate of 130 million checking accounts, some math shows us that they would need to earn $264 more per account to make it up. Given their profit margin, all bank accounts in the U.S. would need to increase deposits by around $7,586. Clearly, that's not going to happen anytime soon, given the recession.

Using banks' actions regarding credit cards as a guide, I suspect banks might just increase the checking account costs on everyone to make up for the money lost on overdraft fees. That might result in paying customers less interest. But since those interest rates are pretty low already, I'd suspect a monthly fee would be more likely. Free checking swept the nation some years ago, allowing Americans to enjoy the convenience of a checking account without paying for it. That may soon change.

According to an FDIC study of overdraft programs from last November, around 75% of account owners had not exceeded their limit in the prior 12 months. That means just 25% of people are currently paying all those overdraft fees. The report indicates that an even smaller subset pays almost all of them -- 93.4% of the fees are paid by those who have had at least 5 overdraft transactions!

Whether or not it's fair for such a small portion of people to carry such a large burden of fees is up to debate. But if they aren't paying, then someone else will. Instead, that $34.3 billion will likely be spread across the rest of us as well.