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Fed takes aim at overdraft penalties
Regulation would ban many fees unless customers opt in

By Ylan Q. Mui
Friday, November 13, 2009

The Federal Reserve will begin banning banks from charging many overdraft fees unless customers sign up for the service, an unprecedented move that comes as a wave of consumer reform sweeps Washington.

The new regulations, announced Thursday, cover overdrafts from ATM withdrawals and debit card purchases, which account for roughly half of overdrawn transactions, and help to address widespread complaints that consumers who were unaware they had insufficient funds were being charged exorbitant fees for purchasing a cup of coffee, for example. The rules, which take effect July 1, 2010, come as banks have drawn increasing scrutiny in the wake of the financial crisis for charging high fees and interest rates at a time when consumers are financially strapped.

Banks will be required to send customers a notice explaining their overdraft protection services and fees before they are asked if they want to sign up. But the regulations do not cover payments made by check or recurring debit card charges, such as automatic bill payments. They also give banks wide latitude over the structure of overdraft fees once customers opt in, though Fed officials said the regulations allow consumers to drop the service at any time. Two bills targeting the fees are under consideration by Congress and would place tougher restrictions on the industry.

Since the financial crisis began, the Fed has been under pressure to demonstrate its concern for protecting consumers and has imposed new limits on mortgage and credit card lenders. The recent spurt of rulemaking follows a decade of inaction during which the Fed ignored mounting evidence of abuses and repeated pleas from consumer advocates. As a result, the Obama administration wants to strip the Fed of some of its responsibilities and create a new agency devoted to protecting consumers. Fed Chairman Ben S. Bernanke has declined to take a public position on the proposal, but he has highlighted the Fed's recent actions as evidence that the institution is aware of its past shortcomings and working to improve.

Fed officials said Thursday that they had been working for several years to refine their regulations on overdraft charges, which infuriate consumers but are a significant revenue stream for banks. Fees from overdrawn U.S. accounts will reach $38.5 billion this year, up from $36.7 billion in 2008, according to research firm Moebs Services in Lake Bluff, Ill. A survey of smaller banks released by the Federal Deposit Insurance Corp. last year showed that about a quarter of accounts had been overdrawn at least once in 2006, the year the study was performed.

Revenue could suffer

Edward L. Yingling, chief executive of the American Bankers Association, a trade group, said the regulations strike a balance between consumer concerns and industry needs. But the group also said its members will be hard-pressed to find replacements for that revenue, especially as the recent wave of financial reforms has limited their ability to charge riskier customers higher fees and higher interest rates for loans. That could mean banks will begin considering charging for popular services that they had provided for free, such as checking and no-minimum-balance accounts.

"There are additional risks and costs that the final rule creates, and they'll have to make adjustments," said Nessa Feddis, ABA senior counsel.

But several consumer groups said the Fed's regulations do not go far enough and have called for all forms of payments -- checks and debit cards -- to fall under the regulations. Fed officials said those forms of payments are typically used for bills, and their research shows that consumers would rather pay the overdraft fee than have such payments denied. According to the FDIC report, about 30 percent of overdraft transactions stem from checks. About 41 percent occur from debit cards, while 7.8 percent are attributed to ATMs.

In addition, consumer groups have criticized banks not only for automatically enrolling customers in potentially costly overdraft protection programs, but also for the size of the fees and the number of overdrafts allowed per month, among other things. That means consumers could still wind up paying $40 for a cup of coffee if they enroll in the service.

The Fed "hasn't solved the bigger problem that once people opt in, it's still an unfair product that perpetuates debt," said Ed Mierzwinski, program director for consumer advocacy group U.S. PIRG.

Congress may weigh in

Two bills -- from Rep. Carolyn B. Maloney (D-N.Y.) and Sen. Christopher J. Dodd (D-Conn.) -- would more aggressively curtail overdraft fees. Both limit overdraft charges at one per month and six per year and require fees to be proportional to the amount of the overdraft. They also prevent banks from debiting the most expensive purchases from accounts first, which could increase the number of overdrawn transactions. Maloney's bill covers checks in the opt-in requirement, but Dodd's does not.

Both lawmakers praised the Fed's action on Thursday but said they plan to move forward with their bills. A hearing for Dodd's legislation is scheduled for Tuesday.

"This is a long-overdue announcement for American consumers," Dodd said in a statement. But, he added, "we need to do far more to protect customers from abusive bank products.

Some banks have already begun making changes to their overdraft programs. J.P. Morgan announced last month that it would begin requiring customers to opt-in to overdraft protection in the first quarter of next year. It also said it would not charge a fee if the account is in the red by less than $5. Bank of America said it would allow customers to opt out of its program and restrict fees to overdrafts of more than $10.

Staff writer Binyamin Appelbaum contributed to this report.

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