Many banks reap huge profits in overdraft fees by allowing customers to overdraw their checking accounts, according to a report by the Consumer Financial Protection Bureau.
Consumer advocates have called for an outright ban on banks' permitting customers to withdraw more than they have available in their accounts.
The median overdraft fee was $34 at the 33 largest financial institutions, and $30 at 800 smaller banks and credit unions in 2012, according to the CFPB's white paper with data from Informa Research Services.
Not surprisingly, consumers who did not opt in to spend more than they had in their accounts saved more money than those who did.
The CFPB found that previous heavy overdrafters who declined to opt in reduced their overdraft and insufficient fund fees, on average, by more than $450 in the second half of 2010. The CFPB studied large banks, with total assets of $10 billion or more, and found a variety of practices in regard to transaction posting orders from high to low and opt-in requirements. Beginning in 2010, the Federal Reserve required banks to ask consumers to opt in to overdrafts.
"While both heavy overdrafters who did and did not opt in experienced a reduction in fees per account in the second half of 2010, the reduction in fees for those who did not opt in was $347 greater, on average, than for those who did opt in," according to the report.
Chi Chi Wu, a staff attorney at the National Consumer Law Center, said the CFPB report substantiated the data trends her organization had suspected.
"One of the things we suspected was that banks make a lot of money from overdraft fees, and those $35 fees are just pure profit for some banks," Wu said.
The CFPB found that 61 percent of bank profits from consumer checking accounts come from overdraft and insufficient funds fees, which are prompted when customers withdraw, make a debit card payment or make or attempt to make another type of payment for more than what is available in their accounts. Only 14.4 percent of net overdraft revenue goes toward the cost of covering unpaid overdrafts.
While Wu and the National Consumer Law Center call for a ban on overdrafts on ATM and debit card transactions, Richard Cordray, director of the Consumer Financial Protection Bureau, said, "Nothing in this report implies that banks and credit unions should be precluded from offering overdraft coverage."
Cordray pointed out that if an institution rejects a transaction, a consumer "may be harmed by the consequences of having the transaction fail," such as when rent or a mortgage goes unpaid because a customer has chosen not to opt in to overdrafts.
"Nonetheless, our findings raise concerns about the number of consumers who are incurring heavy overdraft fees or account closures, and the wide variations across institutions indicate that certain practices and procedures merit further analysis," Cordray said in a conference call with reporters on Monday. "We need to determine whether they are causing the kind of consumer harm that the federal consumer protections laws are designed to prevent."
Wu, on the other hand, said, "There's no reason for overdraft, especially for point-of-sale and ATM withdrawals. The bank can tell electronically if you are going to overdraw."
If a customer does not opt in to overdrafts and tries to spend more than his or her checking account allows, banks typically don't process the transaction, Wu said, adding that the electronic ATM and debit card system can be monitored faster than bounced checks.
At some banks in 2011, more than 40 percent of all new customers opted in to overdrafts, while other banks had only single digit opt-in rates, the CFPB reported.
In March, Rep. Carolyn Maloney, D-N.Y., introduced the Overdraft Protection Act of 2013, which directs the CFPB to limit overdrafts to one per month or six per year, and prohibits banks from manipulating the order of transactions to maximize overdraft fees.
Maloney's legislation would require that overdraft fees "be reasonable and proportional," and codify the Federal Reserve opt-in provisions.
Wu said financial institutions make what she calls "misleading statements" when asking if customers want to opt in. She said banks need to make it clearer what opting in means.
"They made it seem that consumers would be worse off if they did not opt in, whereas we think they are better off not opting in," Wu said.
Wu urges consumers to confirm with their financial institutions that they have opted out of overdrafts.
"Consumers who did not opt in get charged a lot fewer overdraft fees and save a lot of money. Go to your bank and say, 'I don't want debit or ATM overdrafts. There's no harm in telling your bank you're opting out."