CFPB proposes rule to end bank overdraft loophole for large banks

CFPB’s new rule proposal would bring an end to an outdated loophole that exempts overdraft lending services from longstanding provisions of the Truth in Lending Act and other consumer financial protection laws.

Regulating large banks and ensuring fair practices

For a long time, financial institutions have been able to issue highly profitable overdraft loans, which have garnered them billions of dollars in revenue annually. Under the new proposal, large banks would be free to extend overdraft loans if they complied with longstanding lending laws, including disclosing any applicable interest rate. Alternatively, banks could charge a fee to recoup their costs at an established benchmark – as low as USD 3, or at a cost they calculate, if they show their cost data.

Regulator have stated that decades ago, overdraft loans got special treatment to make it easier for banks to cover paper checks that were often sent through the mail. Now, they 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 USD 10 billion in assets, which covers approximately the 175 largest depository institutions in the US. These institutions typically charge USD 35 for an overdraft loan, even though the majority of consumers’ debit card overdrafts are for less than USD 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 USD 3.5 billion or more in fees per year. The potential savings would translate to USD 150 for households that pay overdraft fees.

The Truth in Lending loophole evolution

In 1968, Congress passed the Truth in Lending Act, requiring lenders to disclose credit costs. At the time, many families received and sent checks through the mail, and had little certainty about when their deposits and withdrawals would clear. When a bank clears a check and the consumer doesn’t have funds in the account, the bank is issuing a loan to cover the difference. The Federal Reserve exempted check overdrafts from protections if deemed 'inadvertent.' Initially, this was infrequent and low-cost.

However, in the 1990s, debit card usage surged, leading banks to exploit the exemption, resulting in an estimated USD 12.6 billion in annual overdraft fee revenue by 2019. By 2022, Wells Fargo and JPMorgan Chase dominated this revenue, accounting for one-third of overdraft revenue reported by banks over USD 1 billion. Recent policy changes, prompted by CFPB efforts against illegal overdraft practices, have reduced annual overdraft fee revenue to around USD 9 billion.

Proposed Rule

The proposed rule would require very large financial institutions to treat overdraft loans like credit cards and other loans as well as to provide clear disclosures and other protections. Many banks and credit unions already provide lines of credit tied to a checking account or debit card when the consumer overdraws. The proposal provides clear rules of the road to ensure consistency and clarity.

The CFPB also is proposing to limit the longstanding exemption to overdraft practices that are offered as a convenience, rather than as a profit driver. The proposed rule would allow financial institutions to charge a fee in line with their costs or in accordance with an established benchmark. The CFPB has proposed benchmarks of USD 3, USD 6, USD 7, or USD 14 and is seeking comment on the appropriate amount.