Under a proposed rule announced by the US Consumer Financial Protection Bureau (CFPB), large financial institutions would need to treat overdraft loans just like credit cards and other lending products.

Acknowledging the proposed rule in a statement, President Joe Biden said: “For too long, some banks have charged exorbitant overdraft fees – sometimes $30 or more – that often hit the most vulnerable Americans the hardest, all while banks pad their bottom lines. Banks call it a service – I call it exploitation,” he said.

The proposal is designed to close an outdated loophole that exempts overdraft lending services from longstanding provisions of the Truth in Lending Act and other consumer financial protection laws, the CFPB said.

“For decades, very large financial institutions have been able to issue highly profitable overdraft loans, which have garnered them billions of dollars in revenue annually. Under the proposal, large banks would be free to extend overdraft loans if they complied with longstanding lending laws, including disclosing any applicable interest rate,” the agency said.

“Today, we are proposing rules to close a longstanding loophole that allowed many large banks to transform overdraft into a massive junk fee harvesting machine.”

Rohit Chopra, Director, CFPB

In this way, financial institutions could offer a line of credit linked to a customer’s checking account and debit card. The rule aims to prevent overdraft loans, and the hefty and often surprising fees that come with them, from negatively affecting consumers after they have made a transaction that exceeds their spending limit.

Alternatively, banks could opt to charge a fee to recoup their costs at an established benchmark – as low as $3, or at a cost they calculate, if they show their cost data.

The junk fee ‘harvesting machine’

“Decades ago, overdraft loans got special treatment to make it easier for banks to cover paper checks that were often sent through the mail,” said CFPB Director Rohit Chopra. “Today, we are proposing rules to close a longstanding loophole that allowed many large banks to transform overdraft into a massive junk fee harvesting machine.”

The proposed rule would apply to insured financial institutions with more than $10 billion in assets, which covers the 175 largest depository institutions in the country. These institutions typically charge $35 for an overdraft loan, even though the majority of consumers’ debit card overdrafts are for less than $26, and are repaid within three days.

Approximately 23 million households pay overdraft fees in any given year. The CFPB estimates that this rule may save consumers $3.5 billion or more in fees per year. The potential savings would translate to $150 a year for households that pay overdraft fees, the CFPB said.

“For too long, some banks have charged exorbitant overdraft fees – sometimes $30 or more – that often hit the most vulnerable Americans the hardest, all while banks pad their bottom lines. Banks call it a service – I call it exploitation.”

President Joe Biden

In addition to treating these overdraft loans like credit cards and other loans, the large financial institutions targeted here would also have to provide clear interest-rate disclosures and other protections to consumers.

Many banks and credit unions already provide lines of credit tied to a checking account or debit card when the consumer overdraws; the proposed rule just makes that process more consistently applied.

Targeting junk fees

The proposed overdraft rule is part of a continued effort by the CFPB to rein in junk fees and spur competition in the consumer financial product marketplace. In early 2022, the CFPB launched an initiative to save Americans billions in junk fees, which generated more than 80,000 responses from the public. The overwhelming majority of the responses were complaints about overdraft fees, the CFPB said.

And the CFPB issued guidance to rein in surprise overdraft fees in October 2022.

In a July 2023 enforcement action, the CFPB ordered Bank of America to pay $90m for, among other things, double-dipping on non-sufficient funds fees.

The CFPB also targeted credit card late fees and customer service fees in enforcement actions last year. In February, the CFPB proposed a rule to rein in excessive credit card late fees. And in October, the CFPB issued an advisory opinion to halt large banks from charging illegal junk fees for basic customer service.

Recovering costs

In terms of those instances when the financial institution is simply recovering costs, the CFPB is seeking comments in its rule proposal on whether to give banks the option to charge a prescribed benchmark that doesn’t require them to do their own math.

The Bureau is proposing a benchmark of $3, $6, $7, or $14, and banks would be able to charge more if they calculate a breakeven fee above the benchmark.

The CFPB noted that it is also seeking comment on whether to get rid of this “recovering costs” exemption altogether.