Home Jersey sale The power of next-generation overdraft programs

The power of next-generation overdraft programs


This is the end of overdraft as we know it. Big banks are reinventing their overdraft programs amid heightened regulatory scrutiny and the emergence of challengers offering short-term liquidity offerings that bear little resemblance to traditional fee-based overdraft protection. This is no small feat and could lead to serious financial repercussions for banks that do not manage the transition properly. Traditional overdraft programs are huge revenue streams, earning money for U.S. banks more than $6 billion in the first nine months of 2021 only. Yet the challengers have realized that addressing customers’ short-term liquidity needs in a supportive way – as opposed to a punitive approach – can pay significant dividends in the form of customer acquisition, loyalty and value to life.

Customers and overdraft: it’s complicated

Customers who don’t have access to traditional credit options often need to find financial flexibility somewhere. Despite the high fees, the overdraft fulfills this need. These people, who often lack savings, credit cards and disposable income, use overdraft as a way to access short-term credit to supplement their income between paychecks. For consumers with few other options, overdraft is a quick fix for cash flow problems.

However, overdraft has been shown to do far more harm than good in the long run. The people who need an overdraft the most are those who can least afford the fees, and those fees add up quickly. Very few account holders actually use overdraft options, but those that do, use it a lot. In fact, 75% of all overdraft fees are paid by just 8% of customers, according to the Financial Health Network. With each case of overdraft resulting in charges of $35 or more, it’s not hard to see how this can create a cycle that keeps customers’ accounts continually overdrawn as they try to catch up on bills and other expenses.

Why now?

For years, regulators have watched what they see as predatory overdraft practices, including high fees and the practice of processing debits before incoming credits to maximize fee revenue. Along with regulatory pressure, providers are also facing increased competition from challenger banks and their new approach to overdraft. As a result, banks are reducing NSF fees or eliminating them altogether.

In December 2021, Capital one and JPMorgan Chase both made changes to their policies, kickstarting the change that is now underway in earnest. In January 2022, five of the largest banks in the country—Bank of America, Wells Fargo, American bank, Truist and Bank of Regions— announced changes to their overdraft fee, low value loan and insufficient funds (NSF) policies. Now, Citigroup announced plans to eliminate all overdraft, overdraft protection and insufficient funds fees by this summer. Pew Charitable Trust estimates that the January 2022 changes alone will save consumers more than 2 billion dollars every year.

Not your traditional overdraft

Several neobanks and challenger banks have found innovative new ways to extend small lines of credit to their customers. Some offer advance paydays, microloans, or “buy now, pay later” (BNPL) options to meet clients’ cash flow needs, and have completely eliminated the fees associated with using these options. Although customers generally must meet certain requirements to access these small dollar loans, they are generally more accessible than traditional revolving credit barriers. By tying overdraft alternatives to existing programs that are monetizable, banks can provide flexibility without placing an undue burden on the customer, while still making a profit.

Let’s say a neobank wants to increase usage by encouraging enrollment in its direct deposit program. He may consider rolling out a free overdraft protection initiative for customers who directly deposit at least $500 per month. They can decide that anyone who signs up will have access to a $200 overdraft at any time, and the outstanding balance (at no additional cost) will be refunded on the customer’s next deposit. This model would offer users the option of microloans at no cost while generating revenue for the institution, as direct deposits can be monetized.

This is just one example of the many options available to financial institutions looking to revamp their overdraft models. Fintechs are increasingly developing creative ways to solve customer liquidity issues without using the traditional overdraft model and its associated fees. Whether it’s microloans, temporary loans, early access to payment or something completely new, each bank or fintech must decide which structure is best for them based on their business model, appetite for risk, its client profile and its technological capabilities.

The good news? Customers will reward providers who give them access to the cash they (sometimes desperately) need, especially if it costs nothing. The key is to meet customers where they are and provide them with next-generation banking options that work with them and for them while reinforcing behaviors (like direct deposits) that drive the institution’s profitability. With today’s technology and openness of consumers to new structures and services, an alternative to traditional overdraft could be as simple as reduced fees, as targeted as the neobanking approach described above, or anywhere in between. This is a victory for consumers and banks.