New federal restrictions on overdraft fees will likely take a bite out of many Connecticut banks’ income and force lenders to develop new revenue sources, banking industry officials say.
As part of the new rules set by the Federal Reserve, which went into effect July 1 for new accountholders, banks must receive permission from consumers before covering an overdraft and charging an approximate $30 fee every time the service is used.
The rules address concerns that some bank customers were not aware of the fees and that sometimes the fee was larger than the overdrawn amount.
For example, a consumer would sometimes be forced to pay a $30 penalty for purchasing a $2 cup of coffee with an overdrawn debit account.
Pot of gold
The regulations are being heralded as a key consumer protection and are part of a broader financial services overhaul in response to the banking crisis.
But for lenders in Connecticut and nationwide, it will mean the loss of a profitable pot of gold.
About 86 percent of U.S. banks operate at least one formal overdraft program, and the fees and penalties comprise a large chunk of operating revenue for many lenders, according to the Federal Deposit Insurance Corp.
Banks and credit unions collected nearly $24 billion in overdraft fees in 2008 alone, according to the Center for Responsible Lending.
“I think the impact could be quite significant,” said John Hamby, CEO of Advanced Business Checking Solutions (ABCS), a bank software and consulting firm in Berlin. “If you have that large of a hit on revenue, it could have a huge impact on the bottom line unless you offset it.”
The new rules, which will be extended to existing customers Aug. 1, apply only to one-time debit card purchases and ATM transactions.
Banks are not required to obtain permission to cover overdrafts incurred as a result of payments by check, recurring credit card transactions or scheduled online bill payments.Â
Revenue losses
The big question for banks is how many customers will opt in or out of the service. Financial research and advisory firm Aite Group is projecting that only 41 percent of consumers will continue to use overdraft programs.
Regardless of the percentage, banks will take a hit to their bottom lines. Of the 127 banks recently analyzed by New York research firm Sandler O’Neill & Partners, overdraft fees made up as much as 28 percent of an individual bank’s operating revenue.
Waterbury-based Webster Bank, for example, could be on the hook for up to $23.8 million in lost revenue because of the new rule, while New Haven-based New Alliance Bank could lose up to $5.6 million, according to the report.
Meanwhile, Bank of America could lose up to $2.2 billion in revenue, while Wells Fargo/Wachovia Bank could lose $1.1 billion, the report said.
Pricey changes
Local community banks and credit unions are not likely to be impacted as greatly, experts said, but they will feel some pain.
“Community banks will be impacted,” said Connecticut Banking Commissioner Howard Pitkin, “but I’m not sure to what degree.”
Cary Whaley, vice president of payments and technology policy for the Independent Community Bankers of America, said the biggest cost to small banks may be implementing the technology that tracks overdraft services.
Whaley said many community banks currently don’t have real-time tracking of overdraft fee programs and instead rely on customer interaction.
Adding the new technology could be a “very pricey equation for banks,” Whaley said.
With the expected revenue losses, industry experts agree that banks will need to replace those funds.
New bank fees
One casualty could be free checking. Some larger national banks already plan to eliminate that as a free service in order to generate new revenue sources.
Wells Fargo, for example, the bank whose Connecticut presence grew with its acquisition of Wachovia in 2008, stopped offering free checking to new customers beginning July 1.
Bank of America, too, is tinkering with a similar idea.
Other banks are likely to follow suit.
Whaley said smaller banks may also consider adding transaction fees and could potentially rework all of their deposit-product offerings.
ABCS’s Hamby, a longtime banker and the former president of Glastonbury Bank, said he has always cautioned lenders not to rely too heavily on penalty charges.
Now, he said he is visiting community banks across the state to encourage them to develop more fee-based services, especially business checking and credit card processing for merchants.
In particular, Hamby is encouraging community banks to expand services eligible for lower fees to customers who keep larger business checking balances.
Regulations allow it, but banks do not do it, Hamby said.
Such expansion could include payroll processing, wire transfer, credit card processing, and loan interest, he said.
“We are trying to help banks figure out,’’ Hamby said, “how to increase income from the positive services they provide, rather than rely on penalty charges.’’
