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Moebs briefing: Joint Guidance on Overdraft Protection Programs. What the Final Guidance means and what needs to be done to comply.
On February 18, 2005, federal bank and credit union regulatory agencies announced their final joint guidance on overdraft protection programs. Moebs $ervices commends the Agencies for their work. The Joint Guidance is a strong and resourceful document, which will serve our financial system well.

Two points are important to understand with respect to the just-published Joint Guidance:
  • These are guidelines. The Federal Reserve has not yet published its long-anticipated changes to Regulation DD, Truth In-Savings. Those changes are coming. And Reg. DD changes, as they apply to overdrafts, are important.

  • The Guidance applies to most, but not all financial institutions. In the week preceding the publishing of the Guidance, The Office of Thrift Institutions issued its own guidelines. The OTS guidelines are not as rigorous as other federal agency guidelines.

What is at risk here? The following table identifies the importance of revenue from overdrafts, the risk factor, to net operating income:

Importance of "overdraft protection" services to financial institutions
Overdraft Revenue
as a Percent of
Net Operating Income
Savings Institutions
Credit Unions
Source: FDIC & NCUA 2003 call reports and 5300 reports, and Moebs $ervices estimates

NOTE: The Office of Thrift Supervision issued its own regulations five days prior to the joint Agencies. The OTS “break-away” is interesting in light of the above table. Savings institutions who are overseen by the OTS have the least to lose with the guidelines. The OTS said that overdrafts are not credit. This is a distinction without a purpose.

Importantly, credit unions have the most to lose regarding overdrafts. With over 60% of Net Operating Revenue coming from the flow of funds generated by overdrawn accounts, credit unions must rely on adherence to the Guidance or face the loss of a significant source of income.

Broad objectives of the Guidance
The goal of a governmental directive on financial services such as the Joint Guidance on Overdraft Protection Programs, should be to:
  • serve the consumer
  • provide clear and appropriate guidance for financial institutions enabling them to succeed
  • assist examiners
  • help the economy

Making banking better for consumers, providing financial institutions with clearly stated guidance, benefits the consumer, makes financial institutions stronger and benefits the economy.

The Agencies who wrote the Final Guidance:

  • Department of the Treasury
  • Office of the Comptroller of the Currency
  • Federal Reserve System
  • Federal Deposit Insurance Corporation, and
  • National Credit Union Administration.

Scope and authority
The final joint guidance is intended to assist insured depository institutions in the disclosure and administration of overdraft protection services.

The Guidance culminates months of hearings, review and study by the Agencies on overdraft protection programs. These programs, commonly referred to as "bounced-check protection," are offered by a growing number of financial institutions. They provide consumers with an alternative to overdraft protection via a line of credit or a fund transfer from a linked account.

Other established regulatory requirements:

  • Federal Credit Unions are already subject to certain regulatory requirements including 12 CFR § 701.21(c)(3) which requires federal credit unions to fulfill the following requirements:
    • adopt a written policy specifying the dollar amount the credit union will honor
    • set time limits for the repayment of the overdraft
    • specify the amount of the fee

  • The Office of Thrift Institutions issued its own guidelines in February of 2005. The OTS guidelines are not as rigorous as the Final Joint Guidance.

  • 13 regulatory statutes addressing overdrafts and five state requirements

  • It is a certainty that The Federal Reserve will introduce changes to regulation DD, Truth In-Savings.

Definition: is an overdraft a loan?
The Guidance defines overdraft protection as a service or an accommodation wherein the institution covers a check when an overdraft occurs. When overdrafts are paid, credit is extended.

The Guidance states that an overdraft is not a loan, but it is an extension of credit.

Historically, when an institution covered an overdraft it was done on a discretionary, ad hoc basis. Historically, it was never promoted to consumers. Today, this service is automated. Today, many depository institutions market the service to consumers.

While stating that an overdraft is not a loan, but it is an extension of credit may seem like splitting hairs, it is a distinction with a difference. Since the service is not considered a loan, it avoids the implications of APR and related Truth-In-Lending, Reg Z. If the Agencies had characterized an overdraft service as a loan, their decision would have necessitated a top-to-bottom overhaul of checking accounts regulations.—from APR to uniform commercial code. The Agencies' treatment of an overdraft as credit but not a loan stays within tradition of federal regulation dating back to the introduction of Truth-In-Lending (TIL) in 1968.

Concerns: credit and marketing
The Guidance is concerned about credit exposure. Since an overdraft is now defined as credit, overdraft protection programs may expose the institution to greater credit risk, therefore, the Guidance mandates that institutions underwrite and mange the credit risk.

The Guidance is concerned about overdraft protection programs that are promoted to consumers without clearly explaining the terms and conditions of the service. Promotional materials that tell consumers they have a specified dollar amount of cash available to them over and above their balance, or that the service is a feature of a "free checking" account program will no longer be tolerated.

Key Guidance points

  1. Credit risk management must meet triple standard of:
    1. individual underwriting to determine the consumers' credit worthiness
    2. must adhere to ECOA non-discrimination rules
    3. dollar limit criteria must be well defined and documented
  2. Institutions must provide clear information to consumers
  3. There are penalties for disclosing overdraft dollar limits to consumers
  4. There are special burdens for ATMs

Following is a summary of the issues identified in the Guidance.
The Guidance is organized under three headings:

A full copy of the Guidance is available on line, by clicking here.