Overdraft fee reform has a big, small-bank flaw

Overprotected. A quirk of the American banking industry is that curbs imposed on big lenders often spare the small ones. The reasons are practical, but not always helpful. The latest example is a proposal to limit the fees that banks charge for overdrafts. It’s meant to close a loophole, but instead creates another.

Overdrafts can be punishing for customers whose accounts go into the red unexpectedly. Many banks charge around $35 for a cushion to cover overdraft shortfalls. The Consumer Financial Protection Bureau wants to force the roughly-130 banks it defines as “very large” to charge no more than what the service costs them, or a flat fee of $14 or less, or face onerous disclosure and protection standards like those imposed on credit cards.

Not all banks need this dose of regulatory medicine. Citigroup scrapped overdraft charges two years ago, while Bank of America cut its fees to $10. But they are outliers. While the mega-bank run by Brian Moynihan made just over $100 million in overdraft fees in the first nine months of 2023, according to regulatory filings, Wells Fargo made nearly seven times that, and JPMorgan eight times.

Yet small banks charge high fees too, and often to less affluent consumer bases. Lenders who fall outside of the new rule levy almost twice as much in fees per dollar of deposits than their bigger rivals, extrapolating from the CFPB’s own calculations that banks covered by the rule charged 68% of all overdraft fees but have 80% of deposits.

Analysis by the Brookings Institution presented to Congress highlighted five banks the new rule wouldn’t cover, that in 2021 squeezed out at least four times the fees per account that mega-banks do. It showed that Armed Forces Bank, which makes loans to military personnel, made all of its profit from these fees in the preceding three years. Small banks serve communities bigger banks don’t, but that also means their customers may be more vulnerable to the vicious circle of unexpected fees.

Why leave the overdraft problem only partly solved? One explanation is that the CFPB has rules of its own to follow, and must do extra work to justify rules affecting small businesses. That’s unhelpful for CFPB boss Rohit Chopra as he helps President Joe Biden fight his war on “junk fees” so close to November’s election.

The other reason is that small banks have a special place in politicians’ hearts. Even though their financial returns are often higher than at bigger rivals, they tend to demand, and get, special regulatory treatment. With the economy softening and property loans creaking, a curb on fees could push some local lenders under. No wonder Chopra has chosen to stay within his means.