Has this ever happened to you? An account holder, let's call him Dave Smith, has opened a checking/share draft account at your financial institution. After 30 days of consistent deposit activity, minimum balance requirement and no overdrafts, he qualifies for your institution's discretionary overdraft program.
You give Mr. Smith an overdraft limit of $500—the same limit you assign to every other customer who opens this type of account and qualifies for the service. Mr. Smith can now access your institution's overdraft service (at your discretion) up to the fixed limit of $500.
Fast forward several months only to see Mr. Smith's name on a monthly charge-off report; and you wonder...where did Mr. Smith go wrong?
Or was it us?
While it may seem prudent to assign the same overdraft limit to every account holder who has met the minimum requirements to participate in the service, this approach can actually be too aggressive for some account holders whose financial situations do not warrant the limit.
The safer, more responsible (and more conservative) approach is to assign individualized overdraft limits that change according to the account holder’s ability to repay at any given time. These dynamic overdraft limits are the hallmark of a personalized courtesy pay service—one that pays more items for those account holders who appreciate and can afford the service, while pulling back on overdraft limits for those account holders whose repayment capacity has diminished.
The only way to accurately assign an account holder the appropriate overdraft limit is to establish a daily risk profile based on a myriad of account holder data points, including specific deposit and overdraft activity, related balances and more. Not only does this data-driven approach enable your institution to more accurately and safely help account holders meet their short-term liquidity needs, it also allows your institution to more effectively manage revenue loss and charge-off risk.
The data your institution gleans from daily analysis of account activity and trends can prompt you to take action, such as adjusting overdraft limits, suspending the service, suggesting counseling, etc. in order to preserve the account and its principal before charge-off is the only option.
Additionally—and no less important—the use of dynamic overdraft limits based on the account holder's ability to repay enables your institution to effectively justify your overdraft limit-setting strategies to regulators, who expect institutions to monitor the credit risk of each account holder and make plan adjustments “to ensure that credit risk remains in line with expectations.”
Using account-level data to determine appropriate overdraft limits, your institution can rest assured that it has taken the most conservative and account holder-focused approach to overdraft administration, while managing your overall risk profile.