CUNA Regulatory Comment Call
June 9, 2004
Proposed Guidance on Overdraft Protection Services
EXECUTIVE SUMMARY
The federal financial institution regulators, including NCUA, have issued proposed guidance to assist financial institutions regarding the responsible marketing, disclosure, and administration of overdraft protection services.
The proposed guidance is intended to:
- Ensure that financial institutions adopt adequate policies and procedures to address the credit, operational, and other risks associated with overdraft protection services.
- Alert institutions offering these services to the need to comply with all applicable federal and state laws.
- Provide examples of best practices currently used or recommended by the industry.
Comments on the proposed guidance are due by August 6, 2004. Please submit your comments to CUNA by July 27, 2004.
Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com and to Assistant General Counsel Jeff Bloch at jbloch@cuna.com; or mail them to Mary and Jeff in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601. You may also contact us at 800-356-9655, ext. 6032, if you would like a copy of the proposed guidance, or you may access it on the Internet at the following address:
http://www.federalreserve.gov/boarddocs/press/bcreg/2004/20040528/attachment.pdf
BACKGROUND
Many depository institutions, including credit unions, offer overdraft protection services, in
which the institution sets a dollar limit and pays overdrafts up to this limit without a case-by-
case assessment, while preserving the right not to pay particular items. In November 2002, the
Federal Reserve Board (Fed) requested comment about the operation of overdraft protection programs
as part of a request for comment on revisions to the official staff commentary of Regulation Z, the
Truth in Lending Act (TILA). One issue in which the Fed requested comment was whether the fee
charged in connection with such programs should be considered a "finance charge" under TILA and,
therefore, disclosed as an annual percentage rate (APR).
Click here for CUNA's comment letter
in response to this proposal.
In February 2004, the CUNA Board approved credit union voluntary guidelines with regard to these
programs that we shared with NCUA.
Click here for a copy of these guidelines.
As a result of the comments received in response to the Fed's November 2002 proposal regarding overdraft protection programs, the federal financial institution regulators have now issued interagency guidance to assist financial institutions on the responsible marketing, disclosure, and administration of these programs. Federal credit unions are already subject to certain regulatory requirements regarding these services. These rules require a written policy specifying the amount of overdrafts that will be honored, time limits in which the member must cover the overdraft, and the costs the credit union will charge for providing these services.
DESCRIPTION OF THE GUIDANCE
In general, financial institutions should weigh carefully the credit, legal, reputation, and other risks of these programs. Also, institutions should review their programs to ensure that they do not lead consumers to believe the service is a traditional line of credit, that they do not encourage irresponsible consumer financial behavior that potentially may increase risk to the institution, and that they do not mislead consumers about the costs or scope of the overdraft protection being offered.
Specifically, the guidance addresses the areas of safety and soundness, legal risks, and best practices used or recommended within the industry, as outlined below:
Safety and Soundness Considerations
These programs may involve more credit risks than other types of credit. Therefore, institutions providing such programs should adopt written policies and procedures to address these credit, operational, and other risks. Appropriate risk management practices include establishing account eligibility standards, as well as well-defined and properly documented dollar limit decision criteria.
Institutions should also monitor the use of these programs or accounts on an ongoing basis and identify members who may be excessively reliant on the product or may pose undue credit risk. These programs should be modified, as necessary, to ensure that the credit risk is in line with expectations, which may include disqualifying members from future participation. Reports detailing product volume, profitability, and credit performance should be provided to management on a regular basis.
Institutions are also expected to incorporate prudent risk management practices related to the repayment and suspension of overdraft protection services. These include specific timeframes for members to repay their overdraft balances, as well as suspension if the member no longer meets eligibility requirements, which would include declaring bankruptcy or defaulting on another loan.
Also, overdraft balances should be charged off within 30 days after the amount is overdrawn. For those overdrafts that are individually underwritten and based on the documented assessment of the member's ability to repay, credit unions should continue to apply the charge-off policy for booked loans, as described in NCUA Letter to Credit Unions No. 03-CU-01, titled "Loan Charge-off Guidance," dated January 2003.
With respect to the reporting of income and loss recognition on overdraft protection programs, credit unions should follow generally accepted accounting principles (GAAP) and the instructions for NCUA 5300 Call Report, with overdraft balances being reported as loans. The procedures for estimating an adequate allowance should be documented in accordance with Interpretive Ruling and Policy Statement 02-3, "Allowance for Loan and Lease Losses Methodologies and Documentation for Federally Insured Credit Unions," dated May 29, 2002. The available amount of overdraft balances should be reported as "unused commitments" in the regulatory report. Proper risk-based capital treatment of outstanding overdrawn balances and unused commitments is also expected, which for federally insured credit unions includes calculating risk-based net worth in accordance with the prompt corrective action rules.
Legal Risks
Overdraft protection programs must comply with applicable federal laws and rules, as well as state law requirements. State laws that may apply include usury and criminal laws and laws regarding unfair or deceptive acts or practices. Counsel should review overdraft protection programs to ensure compliance with all applicable laws.
Below is more information about the federal laws and rules that apply:
Federal Trade Commission Act/Advertising Rules - The Federal Trade Commission (FTC) Act prohibits unfair or deceptive acts or practices. Also, NCUA rules prohibit federally insured credit unions from using advertisements or representations that are inaccurate or misrepresent the services being offered, which include making false representations regarding deposit accounts.
TILA - Fees for overdraft protection are not considered "finance charges" under TILA if the institution has not agreed in writing to pay the overdrafts, meaning that the charge does not have to be disclosed as an APR. Even if in writing, the fee is only considered a finance charge to the extent the fee exceeds the charge for paying or returning overdrafts on accounts that do not have overdraft protection. Loans that are later offered to those unable to repay overdrafts within a specified period of time would be subject to TILA disclosures, assuming the loan would have otherwise been subject to TILA by, for example, being payable subject to a written agreement in more than four installments. The regulators have suggested that they may in the future reevaluate the applicability of TILA to these overdraft protection programs.
Equal Credit Opportunity Act (ECOA) - Under ECOA and the Fed's Regulation B, creditors are prohibited from discriminating against applicants on the basis of race, color, religion, national origin, gender, marital status, age, and the fact that income may be derived from public assistance. Therefore, targeting certain consumers for overdraft protection programs while offering other consumers overdraft lines of credit or other more favorable products and services will raise issues under ECOA. Also, ECOA and Regulation B include requirements on procedures and notices to consumers regarding credit denials and other adverse actions. However, adverse action notices would not be required for "incidental credit," which would include credit not subject to a finance charge, not payable by agreement in more than four installments, and not made subject to the terms of a credit card account. Overdraft protection programs would generally qualify as "incidental credit."
Truth in Savings Act (TISA) - Under TISA and Regulation DD, deposit account disclosures must include the amount of fees that may be charged and the conditions under which they would be imposed. Advance notice must also be given of any change that may reduce the annual percentage yield or adversely affect the consumer. For overdraft protection services, disclosures may be required if the service is added to an existing account and the fee exceeds the fee for a returned share draft. Disclosures may also be required if the fees are the same, and the original disclosure did not adequately indicate that the fee would apply to both paid and returned share drafts. Also, TISA prohibits inaccurate or misleading advertisements regarding deposit accounts, and the Federal Reserve Board has recently proposed changes to Regulation DD regarding advertising as they relate to overdraft protection programs. NCUA will issue a similar proposal soon since NCUA's TISA rules must be substantially similar to the Fed's Regulation DD.
Electronic Fund Transfer Act (EFTA) - An overdrawal of an account under an overdraft protection program by means of an ATM withdrawal or point-of-sale debit card transaction is considered an electronic fund transfer subject to EFTA and the Fed's Regulation E. As such, periodic statements must be readily understandable and accurate regarding the debits made, current balances, and fees charged. Terminal receipts must also be readily understandable and accurate.
Best Practices
The following are the best practices that financial institutions should take into consideration, which have been used or recommended by the industry:
- Avoid marketing the overdraft protection program in a manner that encourages overdrafts. Present the program as a means to cover inadvertent overdrafts.
- Fairly explain alternatives to overdraft programs and identify the risks and problems in relying on the program, as well as the consequence of abuse.
- Train staff to explain the program's features and other alternatives.
- Explain that the payment of the overdraft is discretionary and explain when the institution may refuse to make such payments.
- Avoid promoting "free" accounts and overdraft protection in the same advertisement in a manner suggesting that the protection is free of any charges.
- Marketing materials and information should disclose the dollar amount of the fee, as opposed to more general descriptions, such as the alternative of merely stating that the standard non-sufficient fund (NSF) fee will apply.
- Clarify that fees count against the program limit.
- Show when multiple fees will be charged, such as when more than one fee may be charged per day, depending on the number of share drafts presented or other withdrawals made from the account.
- Disclose the order in which the institution pays share drafts or processes other transactions.
- Disclose that fees may be charged in connection with other transactions besides share drafts, such as ATM withdrawals, debit card transactions, preauthorized automatic debits, telephone-initiated transfers, or other electronic transfers, if applicable. If such transactions are covered, the marketing and other information should not imply that share draft transactions are the only transactions covered under the program.
- Obtain the consumer's consent to receive protection or allow the consumer to "opt-out" if the protection is automatically provided, as long as the institution provides a clear disclosure of the opt-out option.
- When consumers use non-check transactions to withdrawal funds, alert the consumer, when applicable, that the withdrawal will trigger the overdraft fees. This may be provided, for example, through an ATM transaction in which the transaction may be cancelled after the consumer receives the notification. If this is not possible, then a notice should be posted on the institution-owned ATM explaining that such fees may be charged if there is an overdraft.
- When disclosing an account balance, the balance should reflect the consumer's funds and not include the amount of the overdraft protection that is available. If more than one balance is provided, the balance without the overdraft protection should be separately and prominently identified.
- Promptly notify consumers each time that the overdraft protection is used. This should indicate the overdraft amount, the fees, the deadline for repaying the overdraft, and the consequence of not repaying the overdraft. All of the terms of the overdraft protection programs should be disclosed again when the service is accessed for the first time. When feasible, institutions should also notify consumers in advance if they intend to terminate or suspend access to the program.
- Consider limiting the number of overdrafts or the amount of fees that will be charged against an account each day while continuing to provide coverage for all overdrafts up to the overdraft limit.
- Monitor excessive usage by a consumer and inform him or her of available options.
- Negative information should not be reported to credit bureaus when overdrafts are paid under the terms of these programs that have been promoted by the institutions.
QUESTIONS TO CONSIDER REGARDING THE GUIDANCE ON OVERDRAFT PROTECTION PROGRAMS
Do you believe the expectation that overdraft balances be charged off within 30 days from the date first overdrawn is reasonable? If not, what should be the timeframe?
Do you agree with the safety and soundness considerations, as outlined in the guidance? Are there any that are unnecessary or should otherwise be excluded?
Would incorporating the best practices outlined in the guidance create any specific problems or issues? Are there other practices that should be included?
Other comments?
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Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com |
