Monday, November 22, 2021

Michael Moebs - The overdraft market has changed, which means credit unions must adapt

LAKE FOREST, Ill.—The overdraft market has changed, which means credit unions must adapt their OD policies if they expect to keep members—especially young members—using their product, says one economist. 

Michael Moebs, economist and CEO at Moebs Services, pointed to all of the developments within the overdraft market this year—big banks eliminating overdrafts and leading many more institutions to follow suit, including a half-dozen credit unions; a focus by Washington and consumer groups on overdrafts; the effects of COVID-19 on consumer usage of the service, and continuing lawsuits against financial institutions over overdraft practices.

Despite the evolution in the market in the last year especially, Moebs emphasized overdrafts are not going away and that annual OD revenue among all financial institutions should climb back to pre-COVID levels. Moebs outlined what credit unions need to do to stay in the overdraft business, serve their members well, and bolster the bottom lines.

“COVID has changed overdraft policy,” explained Moebs. “From work at home to stay at home the consumer is much more aware of their finances today—and they have a record level of savings. Easy online access to move funds has shown paper checks drop to less than 7% of the total payment system. Grandma bounced but mom swipes. The payment system is rapidly changing as are overdrafts.”

Change is Needed

To attract and retain users of transaction accounts, formerly called checking, overdraft policies and strategies need to change, especially if the credit union wants to build its number of younger members, asserted Moebs.

“At $32 billion in net annual revenue, overdrafts are not going away,” said Moebs. “While some senators and representatives are calling for the demise of overdrafts, financial institutions hold the lever over this political challenge. Indeed, what if all depositories bounce all transactions and eliminate overdrafts entirely? Is the consumer better off? So, what are the elements of an overdraft policy that is accommodating, reasonable, profitable, and fair to all?

“As recovery from COVID happens—and ODs only losing 10% of net overdraft revenue industry-wide during the pandemic—overdraft revenue is fully recoverable in 2022 and more than likely top $40 billion by the start of the next decade,” Moebs continued. “Therefore, a new overdraft policy is necessary.

Michael Moebs

“The elements included in a strong overdraft policy are more than just price and volume of classic microeconomics but also value, competition, compliance, risk, relationship and cost,” Moebs went on to say before outlining the “foundations” of overdraft policy.

The Basic Parameters

Moebs pointed out Moebs $ervices, which has surveyed thousands of financial institutions on overdrafts every year for almost 40 years, has found a sound overdraft policy needs to have at least these basic parameters:

Price: “Price appears as potentially the easiest OD element to do, yet is the most difficult to accomplish,” said Moebs. “ODs started years ago because consumers used multi-day processing of payments with checks to float the time to make payment. ODs started as a penalty for overreaching the time it took for the payment to clear causing an overdraft balance. Now, charges can be settled in minutes not days. Today, an overdraft is an error and not a penalty. Prices for errors need to be less than the price for a penalty. That means dropping your overdraft price below $20.”

Value: “Value equals benefit less cost. It is a benefit to pay for groceries on a Thursday night without enough cash in the transaction account, less a reasonable fee. Thus, value is at the heart of the overdraft transaction,” Moebs explained. “Credit unions must be known as the financial institution that pays the groceries on Thursday after work no matter what. This is the monetary worth that is the credit union movement.”

“The big competition in overdrafts is Walmart’s $15 OD fee per transaction,” said Moebs. “So, in addition to adjusting price, what about charging only one fee for end-of-day balance? And, about eliminating overdrafts, remember, what do you think of something you get for nothing, or at no cost?”

Compliance: “Compliance for overdrafts is mandatory—for Truth-In-Savings reporting and listing OD price, Reg E for opting into ODs, while Regulation D for tracking withdrawal limits and reserves has been eliminated. Therefore, compliance is simply part of any good overdraft policy,” Moebs explained.

“Risk of unsecured credit, which is an overdraft, is considered unacceptable by traditional bankers. Yet more than 30% of Americans overdraw their transaction account every year and COVID has made unsecured funding acceptable,” said Moebs. “Ultimately, fintechs could start to target the risk component of overdrafts and reduce OD revenue for depositories. Fintechs started out making loans to businesses. Now fintechs like Chime, Varo, Dave, Money Lion, and others are providing limits of generally $200 with low OD fees. Credit unions need to mirror the transaction account fintechs do and provide larger limits based on a better understanding of the risk component of ODs from many more years of overdraft experience.”

Relationship: “Relationship makes ODs very acceptable since an overdrawn transaction account backed by an auto loan or a home equity loan is very profitable,” said Moebs. “Consider boosting relationships with refund rewards.”

Cost: “With fully absorbed overdraft costs—direct labor, indirect IT processing, and overhead of buildings—puts the cost of overdrafts at about $12.50 for each transaction,” explained Moebs. “Walmart charges $15, thus making $2.50, or 16.6%. This is very fair to provider and palatable for the user.”

“Volume is often constricted with low limits of $500 based on a no-risk approach to unsecured credit,” said Moebs. “Do your limits cover at least a monthly car or mortgage payment? Volume is key to providing value and is strongly related to price too. You need to set your limits at $1,500 or more to cover unexpectant errors made to cover auto loan and mortgage monthly payments by a member.”

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