We can think of no better day than Martin Luther King, Jr. Day to reflect on equality. And while many people this week ponder equality in terms of race, religion or even sexual orientation, we think it also applies to the banking world—specifically to equality in overdraft management.
As public scrutiny mounts and regulatory bodies apply pressure, it is—now more than ever—important that financial institutions manage their overdraft programs judiciously and prudently. Unfortunately, many financial institutions today use outdated programs that not only put the institution at risk when justifying their programs to examiners, but inadvertently dole out disparate treatment to their accountholders.
We are specifically referring to banks and credit unions where personnel are routinely required to make manual pay or return decisions. This occurs more often in institutions with an ad-hoc overdraft policy. But it also occurs in institutions with an automated program where the same or 'fixed' overdraft limit is assigned to all accountholders of a particular product or checking type and the fixed limit isn’t sufficient to cover the overdraft.
Ad-hoc and fixed dollar amount overdraft programs—especially those with limits that aren't revised routinely—require pay/return decisions on a daily basis. In our experience, most of these types of credit decisions are subjective, because they are performed by branch personnel without basing their decisions solely on objective criteria. This practice opens up institutions to claims of disparate treatment from the Consumer Financial Protection Bureau under the Equal Credit Opportunity Act, which is implemented by Regulation B.
Financial institutions that use automated dynamic overdraft limits, however, reduce the need for ad hoc decisioning by calculating and assigning daily limits that change with the accountholder's ability to repay a potential overdraft. The limits are calculated based on advanced algorithms comprised of multiple deposit risk values. Armed with this risk data, financial institutions customize overdraft limits for each accountholder, determining the most appropriate limit for each person within the financial institution's risk tolerance. This automation not only keeps the consumer's best interest in mind, but also gives your financial institution the ability to meet regulators' guidelines for monitoring the "individual credit worthiness of its accountholders."
As a side note, one thing we have learned through our own research of millions of bank and credit union accounts, is that despite what some consumer activist groups claim, it is not the poorest accountholders who most often access overdraft protection services. It is, in fact, those individuals who have consistent monthly deposits greater than $4,000. So while overdraft protection programs have come under scrutiny for 'preying' on the most vulnerable, we thought it was also appropriate on this day to point out that overdraft protection is a valuable service to many consumers who would otherwise have to rely on other, less 'equitable', short-term liquidity options.