CFPB Proposed Overdraft Rule: Risk and Compliance Considerations

Introduction

For over a decade, the Consumer Financial Protection Bureau (“CFPB”) has closely scrutinized overdraft and nonsufficient funds (“NSF”), using its enforcement powers to substantially reduce the overall costs to consumers. Now, with the CFPB’s recent proposal to treat overdraft fees as finance charges subject to Regulation Z, the Bureau seems poised to put even more pressure on financial institutions to change their overdraft practices and further reduce or even eliminate overdraft charges. While the proposal is ostensibly intended to save consumers millions of dollars in overdraft fees, the reality is that the market will likely shift those costs to consumers in other ways — effects the CFPB acknowledges it cannot fully predict.

On its face, the CFPB’s proposed rule only affects the overdraft practices of “very large financial institutions” (those with over $10 billion in assets). But that does not mean financial institutions with assets of $10 billion or less should ignore the proposed rule. In fact, the CFPB indicated it plans to monitor market feedback and ultimately could roll this out to all institutions.

Given the significant impact the proposed rule will have on financial institutions’ overdraft practices, consumer credit availability, and public policy issues, institutions of all sizes should plan to review the rule and provide feedback to the CFPB by April 1, 2024.

Overdraft Options Under the Proposed Rule

The proposed rule offers covered institutions two alternatives: 1) the “breakeven” option, which would effectively allow these institutions to continue offering overdraft as a service, subject to a fee cap; or 2) the “above breakeven” option, which would direct consumers to an overdraft credit product that would also become subject to Regulation Z.

“Breakeven” overdraft fees. Under this option, covered institutions could generally continue to offer overdraft services as they do today if the overdraft fee is capped at the larger of 1) a “breakeven” amount, calculated using the formula included in the proposed rule, and designed to match the institution’s actual costs and losses associated with providing overdraft services; or 2) the CFPB’s set fee (currently contemplated at values between $3 and $14).

“Above breakeven” overdraft fees. This option would allow a covered financial institution to charge an overdraft fee above the “breakeven” amount. However, the option would also, generally, require the institution to treat the fee as a finance charge, effectively turning the overdraft service into a credit product subject to complex consumer lending disclosure requirements under Regulation Z.

Exploring the Risks and Possible Impacts of the Proposed Overdraft Options

The Breakeven Option. From a compliance perspective, staying at or below the “breakeven” fee level would perhaps be a financial institution’s safest and simplest approach, having minimal impact on account disclosures and giving the consumer the benefit of the reduced fees. In fact, many institutions may take the CFPB’s set fee as a matter of practice. However, institutions choosing this option would need to continue to track the CFPB’s benchmark and, if they choose to calculate their breakeven point (as opposed to always taking the CFPB’s limit), would need to periodically update their costs-and-losses calculations.

Institutions that choose to limit their fees could also face losing a substantial amount of income. To make up that revenue, these institutions would need to find other revenue streams, likely leading to increased costs for consumers in areas such as increased account maintenance fees or higher minimum balance requirements.

The Above Breakeven Option. Institutions concerned about the impact on revenue may choose to offer overdraft credit with higher (“above breakeven”) pricing. However, choosing this option comes with significant new compliance considerations and could radically change the consumer’s account opening experience and even impact the overdraft products offered to existing consumer customers.

For new customers, opening an account with an overdraft service is currently a fairly simple process. Today, overdraft services are typically described in the account agreement and the consumer can opt-in to overdraft coverage for ATM and onetime debit card transactions by simply providing their “affirmative consent” using a form similar to Regulation E’s Model A-9. Under the CFPB’s proposal, consumers who want overdraft services may instead find themselves reviewing and signing loan documents.

The proposed regulation will also impact existing customers who currently access overdraft services. Covered institutions would need to transition these customers to an overdraft credit product that complies with the Regulation Z amendments. This could come with many additional compliance obligations, including implementing regulated loan terms and various disclosure timing requirements. All these could vary depending on whether the product was structured as a line of credit, a credit card account, a credit feature, a credit plan, or a credit subaccount. And if the credit were revolving and could be accessed by a debit card (termed a “hybrid debit-credit card” under the proposal), the rule would trigger a laundry list of additional compliance considerations, including some under the Credit Card Accountability Responsibility and Disclosure Act (“CARD Act”).

In another change, under an amended Regulation Z, the institution would no longer be permitted to automatically debit the transaction account to recoup the overdraft and fee amounts. Instead, a periodic repayment agreement would be part of the loan terms, and the institution would be required to offer at least two methods of repayment, one of which is not automatic preauthorized payments.

Unintended Consequences and Other Considerations

The CFPB’s proposed rule raises a number of other issues for consideration, few of which were addressed in any detail by the CFPB’s analysis. For example, credit subject to Regulation Z is also subject to other consumer protection compliance requirements at a state and federal level — such as the Military Lending Act, state usury laws, and the Equal Credit Opportunity Act. The CFPB declined to analyze the impact of such laws, and instead is looking for feedback from financial institutions on that topic.

In addition, the rule may significantly impact the cost and availability of credit for consumers. For example, institutions are likely to shift costs elsewhere and, given credit underwriting requirements and practices, consumers who previously used overdrafts as a form of short-term credit may not qualify for overdraft credit subject to Regulation Z. The CFPB acknowledged it is unable to predict the ultimate impact of the market shift on consumers.

The proposal also raises a number of public policy issues. For example: 1) whether driving toward a “breakeven” amount actually reduces reliance on overdrafts or has the opposite effect, 2) whether the value of deterrence should play a role in the setting of the fee, and 3) whether the value of the service to the consumer should play a role in the setting of the fee. The CFPB’s analysis in the proposed rule does not provide much detail on these topics.

Conclusion

The CFPB’s proposed overdraft rule could dramatically change the overdraft practices of very large financial institutions. These institutions will have to either charge minimal “breakeven” overdraft fees or face a host of compliance, procedural, and market challenges. The CFPB is asking for comment on a number of topics by April 1, 2024, including feedback and reaction to the details of its proposal, the adequacy of the proposed costs-and-losses formula, as well as the likely impact of the rule on the market and consumers’ access to quick credit. Although the scope of the proposal is limited to very large institutions, smaller institutions will want to weigh in, too, since the CFPB indicated it plans to monitor market feedback and may eventually roll this out to all institutions.

About the Authors:

Regulatory compliance experts Therese Kieffer, JD, CRCM, specialized consulting manager; Karl Leslie, JD, MBA, specialized consulting associate director; and Tatyana Wentler, JD, CRCM, specialized consulting manager, work in Wolters Kluwer’s Financial & Corporate Compliance division.