• Federal Banking Agencies Issue Guidance on Overdraft Protection Programs
  • June 30, 2005
  • Law Firm: Mayer Brown LLP - Chicago Office
  • The federal banking agencies recently issued joint guidance regarding the disclosure and administration of overdraft protection programs. The Office of Thrift Supervision ("OTS"), however, issued separate guidance just days before the release of the joint agency guidance. The following article summarizes key points of each guidance and highlights some of the important differences between them.

    Joint Guidance on Overdraft Protection
    The Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and National Credit Union Administration (collectively, "Agencies") issued Joint Guidance on Overdraft Protection Programs ("Joint Guidance") to address issues concerning a service offered by insured depository institutions that is often referred to as "bouncedcheck protection" or "overdraft protection." 70 Fed. Reg. 9127 (Feb. 24, 2005). The Joint Guidance comes at a time when consumer groups and politicians have questioned the high costs and benefits provided by these types of programs. Consumer advocates have noted that these programs provide cash-strapped consumers with access to short term funds at a relatively high cost, much like payday loans.

    Many institutions historically have paid their customers' checking account overdrafts on a discretionary basis as an accommodation, assessing an NSF fee. Recently, several institutions have automated the process for paying a customer's overdraft, and some institutions market their overdraft protection programs to retail customers as short-term credit facilities with express "overdraft limits," which may be subject to fees in addition to the customary NSF fee. These overdraft services differ from traditional overdraft lines of credit in a few ways: (i) an accountholder does not apply to receive overdraft protection, (ii) the institution does not typically perform a formal underwriting process prior to offering the credit service to an accountholder, and (iii) overdraft protection is not subject to the credit disclosure requirements of the Truth in Lending Act ("TILA"). The Agencies provided guidance in three primary areas: Safety and Soundness Considerations, Legal Risks, and Best Practices.

    Safety and Soundness Considerations. The Agencies have taken the position that when overdrafts are paid, credit is extended. Their view is that overdraft protection programs may expose an institution to more credit risk than overdraft lines of credit and other traditional overdraft protection options because such programs lack individual account underwriting. The Agencies recommend that institutions providing overdraft protection programs adopt written policies and procedures to adequately address the credit, operational, and other associated risks. For example, an institution should establish an appropriate monitoring program to identify customers who may represent an undue credit risk.

    Legal Risks. The Agencies clarify in the Joint Guidance that an overdraft protection program must comply with all applicable laws and regulations, including usury and laws that pertain to unfair or deceptive practices. The Joint Guidance notes that the NCUA has promulgated similar rules that prohibit federally insured credit unions from using advertisements or other representations that are inaccurate or misrepresent the service or contracts offered.

    As previously noted, a traditional overdraft line of credit is subject to the disclosure requirements of TILA. Under TILA, fees assessed for paying overdraft items are not considered finance charges, and are not subject to the disclosure requirements, if the institution has not agreed in writing to pay the overdrafts. Nevertheless, TILA disclosures could be required if a consumer enters into a written agreement with an institution to repay overdrafts, and the payments are payable in more than four installments or subject to a finance charge.

    Best Practices. Institutions are encouraged to provide clear disclosures and explanations to consumers regarding the operation, costs, and limitations of a overdraft protection program. For example, a consumer's account balance should represent the consumer's funds distinguished from funds available with overdraft protection. In addition, an institution should not promote a "free" account in a manner that suggests an overdraft protection program is free of any charges. Institutions are encouraged to illustrate the type of transactions covered by the overdraft protection program, demonstrate when multiple fees will be charged, and present alternatives to bounced-check protection in marketing materials to consumers.

    OTS Guidance on Overdraft Protection Programs
    The OTS issued a separate final Guidance on Overdraft Protection Programs ("OTS Guidance") after considering comments received on a proposed interagency guidance to clarify its position. 70 Fed. Reg. 8428 (Feb. 18, 2005). The OTS Guidance is similar to the Joint Guidance in structure and purpose, but differs in its willingness to classify overdraft protection programs across the board as extensions of credit.

    Safety and Soundness Considerations. The OTS recognizes that overdraft protection programs have the potential to expose an institution to a higher level of nonpayment than traditional overdraft lines of credit because the institution has not performed individual account underwriting. Therefore, the OTS recommends that savings associations adopt written policies and procedures to address the risks associated with such programs. The OTS also recommends instituting an account monitoring procedure to identify customers who do not manage their accounts in a satisfactory manner. This may include disqualifying certain customers from future overdraft protection. It is also expected that savings associations will incorporate appropriate risk management practices related to account repayment and suspension of overdraft protection services.

    The key substantive difference between the OTS Guidance and the Joint Guidance, however, is that the OTS has taken the position that some overdraft protection programs are provided to customers as a fee for services rather than an extension of credit. The OTS may consider an overdraft plan to be an extension of credit, however, when the savings association performs a credit check on the borrower, provides a period of time to repay the overdraft, and charges interest based on the amount and duration of the overdraft. Nevertheless, the OTS has indicated that it is not within the scope of the OTS Guidance to determine whether a particular overdraft program is an extension of credit.

    Best Practices. Although the OTS Guidance does not include a Legal Risks section, savings associations are reminded that their overdraft protection programs must comply with all applicable federal laws and regulations. The OTS Guidance includes revised or shortened best practices from the Joint Guidance plus additional best practices. The OTS recommends that savings associations refrain from manipulating transaction-clearing to increase the overdraft fees. The OTS Guidance also advises savings associations to prohibit consumers from accessing overdraft amounts unless the consumer has been informed that the transaction will trigger an overdraft fee and has been given the opportunity to cancel the transaction.

    The increased use of overdraft protection programs and the rising costs for participants prompted the Agencies to issue the Joint Guidance. Whether the Joint Guidance will enhance consumers' understanding of these programs or significantly reduce the number of participants remains uncertain.