By: Jeff Green
May 15, 2014
Most consumers try to avoid overdrawing their accounts, viewing it not just as an embarrassment but also to avoid the subsequent hassles and fees. For others, especially low-income consumers, it's a way of life as they manage their lives paycheck to paycheck.
Different entities have identified this trend, but their practices - and perhaps their motivations - often can differ, and they can present substantial costs to consumers taking out short-terms loans. But many consumers are willing to pay the price when in need of funds to cover their expenses.
Banks have caught on to this, and many now offer overdraft-protection policies, where they will guarantee payments on overdrawn accounts for a fee. Such programs are highly controversial, however, and the Consumer Financial Protection Bureau (CFPB) launched an inquiry in 2012 into the practice and the rates banks apply. The bureau's inquiry into checking account overdraft policies continues today.
When the bureau announced its study, Director Richard Cordray acknowledged that technologies available to consumers today provide greater opportunities to access and overdraw checking accounts. "But overdraft practices have the capacity to inflict serious economic harm on the people who can least afford it," he said. "We want to learn how consumers are affected, and how well they are able to anticipate and avoid paying penalty fees."
A recent Wall Street Journal article helped to paint that picture. It illustrated the conflicting nature overdraft-protection policies have when looking at the perspectives of banks versus consumers. It also pointed out that, while some may view banks' fees as high, they're often lower than the alternatives also available to consumers, especially payday lenders.
The Journal pointed out that about 40 percent of banks operating within Wal-Mart stores, where low-income consumers often frequent, collect more in fees that in loan income, a trait uncommon in most U.S. banks. Most of those fees are for overdraft charges.
Should Wal-Mart pressure banks leasing its store space to lower their fees? A closer look at pricing suggests the banks already are a low-cost short-term loan provider, and Wal-Mart's customers have caught on to that.
As an example, the Journal cited a customer of Woodforest National Bank, which operates in 702 Wal-Mart stores. He withdrew $300 from the bank, which then repaid itself that amount plus a $30 fee from the customer's disability check three weeks later, an amount equivalent to a 175 percent annual percentage rate (APR). While that may seem high, a typical Cleveland payday lender, the Journal pointed out, would charge $45 on a two-week $300 loan, representing a 391 percent APR.
"I try not to overdraft every month," the customer was quoted in the story. "It's good for emergencies, especially for people with limited income."
'Operation Choke Point'
The CFPB is not alone in looking into the high rates low-income consumers pay on short-term loans. In its "Operation Choke Point," the U.S. Department of Justice is looking into payday lenders. Its focus primarily is on such lenders operating in states that prohibit the practice and on banks that extend them lines of credit. But it's also calling on banks to shutter, or "choke off," accounts that may be used for suspicious activities, such as money laundering and fraud.
The controversial secret operation, which may not even be legal, launched in 2013 as a policy initiative of the president's Financial Fraud Enforcement Task Force, which includes the Federal Deposit Insurance Corp., the CFPB and other regulatory agencies. While it puts banks into a role of "policemen," it also potentially puts overdraft policies as risk, thus pushing consumers who use them for legitimate purposes into more-expensive alternatives, such as payday lenders, should banks view their activities in using the short-term loans as "suspicious.
The fact that the bureau has yet to act in its inquiry illustrates the complexity of doing too much in the name of "helping" low-income individuals. As a recent editorial in Investors.com pointed out, efforts to shut down even payday lenders have only harmed consumers, many of whom were forced to turn to loan sharks for emergency funds.
Worsening the problem
A 2007 study by the Federal Reserve Bank of New York found that cutting off the supply of payday credit only worsens consumer credit problems, the editorial noted. After Georgia and North Carolina banned payday lenders last decade, more consumers there bounced checks and filed for bankruptcy than did borrowers in states that allowed payday lenders, the study found. And the loan-shark business picked up.
After Hawaii in 2003 opened up payday lending, in contrast, borrowers' debt problems declined and became less chronic, and bankruptcies fell, the editorial pointed out.
Implementing regulations to prevent consumer harm is a good thing. But when the outcome doesn't meet that goal or may actually create bigger problems, it's best to just let the market address the situation. Wal-Mart appears ready to do that with its banks, and perhaps the government might do well to do the same.