Debit cards fees have become a major source of revenue for banks as their profits from other business shrink. For consumers, the quickly mounting fees -- as much as $35 for each overdraft -- can become a financial disaster. Some in Congress have noted that this practice is particularly harmful for low-income and elderly consumers who often don't know that they are being charged. But bankers say that overdraft service and fees can be easily avoided if consumers simply don't spend more than what's in their checking accounts.
Where does the responsibility lie? Is it with consumers who fail to balance their checkbooks and unwittingly rack up these fees? Or should there be tighter federal regulation of debit cards and overdraft fees?
Regulators Must Step In
Rebecca Borné is policy counsel at the Center for Responsible Lending, a nonprofit research and policy organization.
The banking industry perpetuates the myth that it charges overdraft fees to deter customers from overdrawing again. But small debit card purchases are the most common trigger of overdraft charges. The sure-fire way to deter overdrafts is not by covering them and surprising consumers with a fee. It's by denying the transaction in the first place. That's exactly what most banks did as recently as 2004.
Not anymore. Today, most banks cover transaction after transaction, charging an average $34 a pop and collecting at least $7.8 billion a year in debit-card overdraft fees. Why should a $6 sandwich end up costing $40?
We need an agency dedicated to consumer protection -- now.
Low-cost reasonable alternatives exist, like a line of credit or automatic transfer from a savings account. But banks only automatically enroll customers in the costliest program, and they do so without obtaining a customer's explicit consent. Then, the banks subject customers to pervasive practices designed to maximize unexpected fees. For example, nearly all banks clear debit transactions from highest to lowest, rather than in the order they occur -- a practice that depletes an account more quickly to maximize overdrafts.
To turn this unfair system around, regulators should acknowledge that overdraft fees on debit card purchases and A.T.M. withdrawals are never justified because the bank could easily deny the transaction for no fee.
They should make banks obtain a customer's explicit permission before enrolling anyone in a program that covers overdrafts for a charge. And they should require that overdraft fees bear some relationship to a bank's cost of covering the overdraft, as Congress just required for credit card penalty fees.
Instead of competing on who can offer the most valuable services, our nation's banks seem locked in a race to the bottom. The Federal Reserve has waited too long to step in and require fair overdraft practices. That delay is a good example of why an agency dedicated to consumer protection -- the Consumer Financial Protection Agency, currently under consideration by Congress -- is needed.
Banks Deserve the Compensation
John Berlau is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute, a free-market think tank.
As banks have lowered limits on credit card lines -- partly as a result of the misguided "Credit Card Holders Bill of Rights" that passed Congress last May and put severe restrictions on card issuers' ability to adjust rates for a customer's credit risk -- debit card use is on the upswing. Debit cards offer the convenience of credit cards, including the security of not having to carry around cash that could be subject to loss or theft.
Consumers need to realize that overdrafts are loans that come with fees associated with a bank's willingness to take on risk.
But unlike a credit card, debit cards are linked directly to bank accounts, and do not have the feature of a "balance" that can be paid off in 30 days. If a consumer runs up charges that exceed the value of his or her bank account, the bank is not obligated to cover any of these charges. However, many banks offer "overdraft" protection that will cover certain amounts go past the amount in customers' accounts. But as with any extension of credit, the bank will typically charge a fee and interest.
Anecdotes have focused on consumers allegedly paying $40 for a fast food item because they didn't know they had overdrawn their accounts. But surveys even from critics of overdraft fees show that these consumers are a minority, and that the vast majority keep careful tabs on their accounts. A March survey commissioned by the Center for Responsible Lending found that 72 percent of bank account holders had not overdrawn in the past year.
Consumers using debit cards need to keep track of their accounts and treat overdrafts as a type of loan. They should also shop around with banks and credit unions about various options that would better serve them in the use of debit cards. Fees and interest can be lowered by setting up "linked accounts" that will draw from a consumer's credit card or line of credit when their checking accounts are overdrawn. In fact, the Center for Responsible Lending survey found that about a third of consumers have such linked accounts.
As for Congress, it should resist legislation by anecdote, particularly price controls on overdraft charges. If banks can't be compensated for the risk in allowing overdrafts, many wouldn't offer this option, and many consumers would suffer the embarrassment and inconvenience of having to put items back when they overcharge. Some consumers also knowingly use overdrafts as a type of loan. As long as they know the terms of such a transaction, they should have the ability to do this as consenting adults.
Congress should also turn down corporate welfare demands by big retailers to in effect force many consumers into debit cards by putting price controls on the "interchange fees" that merchants pay to credit card issuers. This would shift these processing costs to consumers, and lead to a reduction in credit card "rewards" such as airline miles, as has happened when interchange fee controls were pushed through in Australia.
Credit and debit cards both offer benefits to consumers, and competition and accurate disclosure will give them a variety of options to choose from. Price controls limit these options with many destructive unintended consequences.
A Simple Technological Answer
Samuel L. Myers, Jr., an economist and professor of policy analysis, is director of the
Debit cards can offer a better way to manage your money than credit cards. They serve as a form of cash, and in many instances can be used wherever credit cards are accepted.
This is particularly true for the poor who are less likely to have credit cards. However, good management of debit cards rarely improves one's credit score. Moreover, there is a perverse relationship between poor credit and debit cards: those with poor credit are unable to get credit cards and thus end up using debit cards (or cash or checks) and then are unable to accumulate the credit records required to improve credit.
When there is a potential overdraft, the transaction should be declined. Why is this so difficult?
Historically African Americans have saved and did not use credit as a form of purchasing consumer products, as my research with Sheila Ards on consumer credit and savings behavior ("The Color of Money: Bad Credit, Wealth, and Race," American Behavioral Scientist 45(2) (October 2001)) showed.
This all changed and now blacks and Hispanics have far lower credit scores than whites and much higher debt levels. They are more likely to default on loans and are more likely to face foreclosure. But this is not because of inherent deficiencies in their ability to manage their funds. Rather, it is often the result of policy-induced actions by lenders and banks.
While I would argue that debit cards are a better way to manage finances than are credit cards, I think the simple application of existing technology would prevent overdrafts on debit cards, and the high fees that follow.
Whenever there is a potential overdraft, the transaction should be declined. This is certainly what happens when a credit card user exceeds her credit limit. What prevents the banks from using the same automatic system to decline purchases or A.T.M. withdrawals when there is a potential overdraft?
Permitting (or encouraging) overdrafts and then charging for them is almost criminal. The solution, in my view, is to give customers the option of paying an overdraft fee (secured by a line of credit or a savings balance) or always having a transaction for which there are insufficient funds declined. Why is this so difficult?
Transparency on Transactions
Ronald J. Mann is a professor at Columbia Law School and author, most recently, of, "Charging Ahead: The Growth and Regulation of Payment Card Markets Around the World."
For the average consumer, borrowing typically comes at three interest rates: 18 to 24 percent on a credit card, 400 to 500 percent on a payday loan, and 1000 to 3000 percent for an overdraft on a debit card.
The Federal Reserve and Congress are now considering ways to address the issue of overdraft fees, notably by requiring that consumers receive more disclosure about the fees at the time a checking account is opened. The recent New York Times editorial goes further, suggesting that banks must notify consumers at the point of sale before finalizing a transaction that would result in an overdraft fee.
It is not at all clear that consumers would reject overdraft services, even with high fees, if given a choice.
I believe that automatic notification when an account is overdrawn at the point-of-sale would be far more effective than the paperwork-related reforms currently on the table. Simply putting disclosures on a form -- even if the information is detailed about risks and fees -- is just too remote from the actual transactions that could result in high fees. Of course, banks are not vigorously opposing this paperwork regulation precisely because it does little to change consumer behavior.
By contrast, regulations to require disclosure of overdraft fees at the point of sale on debit cards (and over-the-limit fees on credit cards) would make the fees truly transparent at the moment they are imposed.
Who is to say how consumers would respond? Would you want to pay $25 extra for that cup of coffee when you easily could pay with cash in your pocket? Would you want to pay $25 extra for the week's worth of groceries you are buying to tide yourself over until your next paycheck?
To be sure, redesigning the software for payment card terminals requires new resources, but those terminals are upgraded to accommodate new services every few years. A phased-in requirement would not impose a big financial obstacle to banks or retailers.
On the other hand, the benefits of such a requirement are substantial. It is not at all clear that consumers would reject overdraft services, even with high fees, if given a choice. But unless banks allow this kind of transparency, we won't know the answer.
Enabling Destructive Behavior
Richard Briesch is associate professor of marketing at the Cox School of Business at Southern Methodist University. His research focuses on modeling consumer decision making, pricing and sales promotions.
While the issue of overdraft fees for debit cards is clearly important, when a consumer habitually overdrafts a debit card (i.e., has one or more overdrafts every several months), it becomes a symptom of a deeper problem: the lack of financial literacy.
This lack of financial literacy is an epidemic in the United States. A recent study by Harris Interactive found that 57 percent of households do not have a budget, 32 percent do not have any savings and 26 percent admit to not paying all of their bills on time.
Banks should be required to make the fees proportional to the overdraft amount.
A study by Professor Annamaria Lusardi at Harvard showed that financial illiteracy is rampant in the U.S. and has a disproportionate effect on minority groups. More evidence of this problem comes from a recent report by the Heritage Foundation, suggesting that 60 to 80 percent of the homeowners who refinance their mortgages through the Homeowner Affordability and Stability Program will fall behind on their mortgage payments within one year. The clear implication is that financial illiteracy has an effect on every aspect of the consumer economy.
More financial education, possibly starting as early as middle school, could help. The U.S. government has a Web site devoted to providing financial education, and banks and other financial institutions provide free financial education as well.
Consumers have to take responsibility for their financial decisions. But does that mean that the overdraft fees are fair?
Banks should, of course, be able to recover their costs associated with overdrafts, and should be able to provide services to consumers who request and can afford them (i.e., "opt-in" to the service). However, consumers should not be charged $35 for a cup of coffee, or have $200 worth of overdraft charges for $17 worth of goods.
Banks should not be allowed to be enablers of financially self-destructive behavior. They should be required to make the fees proportional to the overdraft amount, and be required to deny transactions for consumers who habitually overdraft their debit cards.
Can't Balance Your Checkbook? Use Cash.
Dave Ramsey is the host of "The Dave Ramsey Show," the popular weekday national radio show based in Nashville that focuses on money management. He is the author of several best-sellers, including "The Total Money Makeover."
A few years ago using a debit card guaranteed that you couldn't spend more money than you have. Unfortunately, banks found another way to make money by allowing debit card users to go past their balance and then charge them an overdraft fee. Of course, these fees aren't an issue if you are living on a budget, know how much you are spending and don't spend more than you have.
You have to take responsibility for your finances -- you can't rely on the bank to do that. They are in the business of making money, not the business of making sure you are responsible with yours.
Do a written budget every month. Give every dollar that you make a name before the month begins. Income minus outgo should equal zero at the bottom of the page. Then stick to the budget. If you have trouble sticking to the budget while using a debit card, then try using cash.
We have an emotional attachment to cash -- it hurts when we have to give it up. That makes us think more carefully about our spending. If you use cash for awhile you'll get used to staying on a budget. Then you can go back to using debit cards ... without the overdraft fees.
Bounced-Check Economics
Todd J. Zywicki is a professor of law at George Mason University and a senior scholar at the university's Mercatus Center. He contributes regularly to The Volokh Conspiracy, the legal weblog.
Last year, use of debit cards by consumers surpassed the use of credit cards. This substitution trend will likely accelerate this year as continued problems in credit markets have reduced the supply of credit at the same time that newly enacted regulations on credit card terms have led to higher prices, lower credit limits, and reduced availability for credit cards.
A debit card, of course, is nothing more than an electronic version of a check. Yet although consumers see nothing objectionable about being assessed fees or overdraft charges for bouncing a check, there has been widespread outrage that similar fees are inappropriate for debit cards. Are they right?
Overdraft insurance is expensive, but a bounced check costs far more.
For an economist, the basic question is a simple one: when a consumer exceeds the amount in his bank account, would most consumers prefer to have the payment later dishonored (as with a bounced check) and be forced to pay the equivalent of bounced check fees, or would a borrower prefer to have the payment approved and be assessed an overdraft fee
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