The CFPB's Proposed Overdraft Regulation

The CFPB proposed overdraft regulation came out today. It's a big deal. If it becomes effective, it will dramatically reduce overdraft fees at large banks.

Currently fees for “courtesy” overdraft—where the financial institution is not contractually obligated to allow the overdraft, as opposed to contractual overdraft lines of credit—are not “finance charges,” so the overdraft is not “credit” for purposes of the Truth in Lending Act/Regulation Z because credit requires either a finance charge or a requirement of repayment in over four installments. That means that TILA disclosure requirements do not currently apply to any courtesy overdrafts. 

The CFPB is proposing changing this for overdrafts that don't fall within a dollar amount safe harbor.

Under the CFPB’s proposal, courtesy overdraft charges by banks with over $10 billion of assets will be treated as finance charges—requiring TILA disclosure in advance—unless they fall into a safe harbor. For all practical purposes that means that big banks will not offer courtesy overdraft outside the safe harbors because it is simply not practical to do TILA disclosures for a courtesy product. The regulation’s structure also makes the contours of the safe harbor critical. The safe harbor is for charges that are under a dollar cap that is the greater of (1) a dollar figure that remains to be determined, but between $3 and $14 and (2) the breakeven cost of offering overdraft credit for the bank. Additionally, a charge imposed in connection with an overdraft will not be considered a finance charge if it is less than the charge that would be imposed without an overdraft (e.g., an NSF or return item fee).

While this is straightforward enough, the technical workings of the proposal are a bit tricky to follow. First, under the proposal, the definition of “finance charge” in Reg Z would be amended to include “any service, transaction, activity or carrying charge” on a “covered asset account,” which is in turn defined as “a checking or other transaction account…provided by a very large financial institution that is tied to overdraft credit provided by the very large financial institution.” A “very large financial institution” is a bank or credit union with at over $10B in total assets. That’s currently 176 financial institutions, but the number will grow because the $10 billion threshold is not inflation adjusted. That would make it seem as if all overdraft charges by big banks are finance charges, but the proposed regulation then reinstates the exemption for courtesy overdraft, but carves out from the exemption overdraft charges that are not “above breakeven overdraft credit.” That term is defined as any overdraft the fee for which exceeds either the dollar figure tbd by the CFPB or a cost metric the bank must itself calculation about its own costs of providing overdraft. 

The impact of the rule, if finalized, will be substantial. It will significantly reduce overdraft revenue at the largest banks (many of which have already been reducing their overdraft fees). Using a 2022 baseline, the Bureau calculates that a $3 safe harbor would safe consumers $5.6 billion annually, while a $14 safe harbor would save them $3.5 billion. Those savings would be concentrated on the relatively limited subset of consumers (~17% annually) who overdraw, particularly that further subset who are repeat overdrafters:  93% of fees are charged to those consumers who overdraw 4 or more times annually.  

As with almost every other CFPB rule these days, I think it's fair to expect some sort of litigation challenge, and one area where this rule seems vulnerable to me is its decision to exempt smaller banks, some of which have been the most aggressive in pursuing overdraft fee income. Bureau rulemakings are supposed to consider the impact on smaller financial institutions, but that analysis simply isn’t in the proposed rulemaking. The Bureau hardly even attempts to justify the size distinction. The $10 billion figure corresponds with the statutory scope of CFPB supervision, but has no obvious connection to overdraft.

The proposal has a throw-away line about compliance burdens on small institutions, but there's a huge difference between the burdens on a $9 billion bank and on a $50 million one-branch operation. In any case, it's hard to see a major compliance burden here for the central piece of the rule: it is incredibly easy for any bank to limit its overdraft fees to the fixed dollar safe harbor proposed by the Bureau. Calculating the alternative safe harbor amount would more complicated, but a small institution can readily comply with the fixed dollar alternative, which might even be more favorable.

In any event, it's hard to understand why a consumer’s protections would depend on the size of his or her financial institution. The CFPB was specifically charged with making sure that there’s competitive regulatory parity for banks and nonbanks. It’s strange to think that regulations should apply differently based on bank size, but not based on chartering. There are small institution exemptions from some regulations (small bank exemption from CFPB supervision, Durbin Amendment, small creditor portfolio loan QMs), but those were are statutory carve-outs based on political calls made by Congress. I don’t think we’ve ever seen a small institution carve-out for substantive protections that exists solely through CFPB regulation. (Obviously there is different supervision based on "larger participant" rulemakings, but those rules have to come up with a reasonable way to define who is a larger participant in a market.) Indeed, even the statutory carve-outs aren't really depriving consumers of substantive protections, unlike the proposed rule.

All of this is to say that restricting the rule only to large institutions, particularly without any supporting analysis, could tee up an APA challenge. Regardless of the substantive decision, this is something the Bureau needs to address in any finalized rulemaking.