Overdraft: Against the Flow of Financial Inclusion and Economic Recovery Efforts

Written by Dory Rand on July 17, 2014 - 1:51pm

Access to affordable banking services helps people build wealth, but some persistent barriers deter consumers from opening or keeping a bank account. In the Pew Charitable Trusts’ recent report entitled Overdrawn: Persistent Confusion and Concern About Bank Overdraft Practices , based on a nationally representative survey of American adults, the authors found that 13 percent of people who paid an overdraft penalty say they no longer have a checking account; 19 percent report responding to overdraft fees by discontinuing overdraft coverage; and 28 percent report closing a checking account in response to overdraft fees. 

The report makes it clear that overdraft products are one of the reasons that people do not participate in the mainstream financial system and often end up paying more for financial transactions at alternative, non-bank financial services providers. We know from the Federal Deposit Insurance Corporation (FDIC)’s 2011 survey that half of the over 10 million unbanked households in America were formerly banked. At a time when a growing number of government agencies, nonprofits, banks, and credit unions are trying to implement financial inclusion policies, it does not make sense to allow products such as overdraft to drive people out of the mainstream.

Many financial inclusion efforts aim to bring groups most likely to be excluded from the financial mainstream into the fold, including lower-income persons and communities of color. The Pew report shows that these groups use overdraft at rates higher than their share of the population. For example, people with income less than $15,000 represent 17 percent of overdrafters (the highest percentage of any income group), but only 14 percent of the population. Similarly, African Americans and Latinos represent 18 and 19 percent of overdrafters, but only 11 and 13 percent of the population, respectively.

The impact of high-cost overdraft penalty and transfer fees is not limited to low-income consumers and communities of color, however. The Pew report states that 10 percent of all Americans paid at least one overdraft penalty fee and another five percent paid an overdraft transfer fee in 2013.

The over $30 billion in overdraft fees banks collect annually from American consumers wreaks havoc on individual finances and drives people out of the financial mainstream. The enormity of these fees also further exacerbates our slow economic growth by removing money from the pockets of people who would otherwise spend that money in the local economy. Better consumer protection and bank regulation policies could allow that money to flow back into the economy where it would support local businesses and job growth.

Woodstock Institute applauds Pew for this valuable report and its policy recommendations, including:

• The Consumer Financial Protection Bureau (CFPB) should require financial institutions to make overdraft programs safer and more transparent by ensuring that consumers understand their options for overdraft coverage; and

• CFPB should prohibit the practice of transaction reordering that maximizes overdraft fees and ensure that fees are reasonable and based on the actual cost to the financial institution providing the service.

The CFPB is scheduled to issue pre-rules on overdraft in 2015. Sign up for our mailing list to learn more about what you can do to influence the rules when they are released.