UA study: Banks lose billions with overdraft policy change

A new study by finance researchers at the University of Arkansas shows that U.S. banks are losing anywhere from $3.8 billion to $5.3 billion in annual revenue due to the Federal Reserve’s 2010 changes to overdraft policy.

“The lower fee revenue may further impair the ability of banks to lend money, which will prolong economic weakness,” said Tim Yeager, associate professor in the Sam M. Walton College of Business. “This comes at a time when bank revenues are already strained by reductions in interchange fees, a weak economy and ongoing weakness from the financial crisis.”

Yeager and student Kyle Mills examined the impact of changes to Regulation E, the Electronic Fund Transfer Act, and found that low opt-in rates by consumers decreased the number of accounts from which overdraft fees were generated and thus adversely affected bank revenue both nationally and in Arkansas.

Until recently, most banks automatically enrolled consumers in an overdraft protection service that charged a fee for one-time debit card transactions and automated teller machine withdrawals that exceeded a customer’s account balance. However, effective July 1, 2010, changes to the Electronic Fund Transfer Act required that consumers opt-in to these overdraft services. Accounts created after the mandatory compliance date of July 1, 2010, were immediately subject to the new opt-in procedure.

If an existing account holder did not opt-in to a bank’s overdraft protection service by Aug. 15, 2010, then the bank was required to remove the fee-based, overdraft protection service from the consumer’s account. The overall effect of the Federal Reserve’s new policy has limited the banking industry’s ability to generate fees through overdraft protection services, Yeager said.

He and Mills surveyed Arkansas banks and found that only 31.4% of all account holders opted for overdraft protection on one-time debit transactions and ATM withdrawals. Because their sample size was small, the researchers validated the accuracy of the low opt-in rate by comparing their study to a recent Center for Responsible Lending study, which revealed a similar rate – 33%.

To quantify the revenue decline, Yeager and Mills analyzed quarterly report data from 7,034 U.S. banks from the fourth quarter of 2008 through the second quarter of 2011. They focused specifically on changes to quarterly deposit service charges relative to transaction deposits. Their analysis controlled for the effects of bank size, deposit growth, changes in deposit insurance and county unemployment rates, which can affect deposit service charges depending on whether customers overdraft more often to cover cash-flow shortfalls.

The researchers found that for the median Arkansas bank, the estimated annual revenue loss was between $154,000 and $168,000. For U.S. banks with the same amount of deposits, the estimated annual revenue loss was between $105,000 and $120,000.

“Clearly, changes to Regulation E have adversely affected bank revenue nationwide,” Yeager said. “It will be interesting to see how banks respond. Because the drop in revenue is quite sizeable, I think many banks will take steps to reduce overhead expenses or raise fees elsewhere to offset the lower revenue.”

Yeager holds the Arkansas Bankers Association Chair in Banking. He was an economist at the Federal Reserve in St. Louis.