Regulators Say Overdraft Protection Is a Loan in Disguise

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Many banks let consumers spend more money than is in their accounts under the name of overdraft “protection.” For a fee—$34 on average—banks front the amount overdrawn, which they then deduct when the consumer next makes a deposit. A few prepaid debit cards allow overdrafts as well, typically for $15 a pop. Banks call this a service. The Consumer Financial Protection Bureau disagrees. In a new set of rules for prepaid cards proposed on Wednesday, the CFPB says charging to overdraft is actually a form of credit.

This is not just semantics. The CFPB says if prepaid card issuers offer overdraft protection (and charge for it), they must give consumers the same protections they do with credit cards. That includes basic underwriting to determine that the consumer has the ability to repay the loan and more time to repay the overdraft before charging a fee. The proposed rules also require card issuers to use the word “credit” to describe overdrafting, something that could conflict with the reassuring marketing of “prepaid” cards.

Only seven of the 325 prepaid cards reviewed by the CFPB offered overdrafts, but several of those cards are issued by NetSpend, one of the larger players in the market. The bigger question is whether the CFPB will use the same philosophy of considering overdrafts to be “credit” as it looks at traditional checking accounts. The bureau has been studying checking account overdrafts for more than two years and found numerous “concerns” that consumers end up paying what amounts to an annual percentage rate of 17,000 percent or more. There are some differences between checking and prepaid cards—for example, knowing the balance of a checking account can be complicated by checks, which take longer to clear—but at its core, the product serves similar functions.

The new rules propose other requirements, including a standard way to disclose the dozens of fees that issuers charge on prepaid cards and making it explicit if the accounts aren’t protected with FDIC insurance. The rules also cover a broad range of accounts in which customers hold and transfer money, including some Silicon Valley darlings of mobile and peer-to-peer payments. Square Cash, PayPal, Venmo, and Google Wallet were all included in the list of prepaid programs the bureau reviewed.

The proposed rules are open for 90 days of public comments, and there’s no doubt the industry will push back. Overdraft fees are almost pure profit for banks and can be incredibly lucrative. At community banks in particular, overdraft fees make up 27.5 percent of net income after taxes. Calling overdraft credit isn’t a precedent banks will want to support.