The Real Lesson Behind Excessive Overdraft Fees

When you remove the financial safety net, and individuals understand the choices, they are surprisingly good at doing the right thing.

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What’s more effective: consumer protections or consumer education that leads to sound individual decision-making?

There is a place for both. But those who question whether financial education works would do well to consider the Consumer Financial Protection Bureau’s new report on bank overdraft fees, which in my opinion demonstrates that when individuals understand their choices, they will protect their pocketbook all on their own, thank you very much.

Unfortunately, as the report also shows, individuals too often do not understand the choices. That is the watchdog bureau’s central finding and helps make the case for greater regulation. The report concludes that “each institution’s overdraft policies, procedures, and practices are highly complex and can be difficult for a consumer to navigate.”

Among the overdaft complexities:

  • Complicated fee structures Bank polices vary widely. Some cap daily overdraft charges to two a day while others allow you to pile up insufficient funds fees 12 times a day.
  • Coverage limits Some banks have fixed limits on how much they will lend on a check or debit with insufficient funds; others vary the limits based on average daily account balance, overdraft history, and deposit patterns.
  • Complex transaction postings The order in which check, debit card, and other transactions are posted to an account can influence the number of overdraft fees—and banks all do this differently. Some process transactions at periodic intervals throughout the day, some only at night. Some process debits in order, some from largest to smallest during a single day.

You can see why confusion reigns. But it was another part of the report that caught my eye: The fact that so-called heavy overdrafters reduced their bank fees by a significant amount after declining overdraft protection. “The average checking account fees per account holder who chose to opt in (to overdraft protection) were $196 in 2011, while the average fees for those who did not opt in were $28,” the report states.

(MORE4 Reasons Excessive Overdraft Fees Just Won’t Go Away)

Just to be clear here, I’ll reiterate: The people who did not opt into “overdraft protection” spent far less on fees than those who did opt in. How can this be? How can a person incur seven times more fees with overdraft protection than without it? One explanation, again, is that the rules are so confusing that individuals don’t understand how to manage the feature; those with overdraft protection paid through the nose out of confusion and misunderstanding.

But another way to read this data is that once individuals chose to skip overdraft protection they understood that they were on their own and became a lot smarter about managing their money as a result. In other words, when they felt they had a backstop they didn’t pay attention. But when they understood that the backstop was expensive, and got rid of it, they quickly learned how to watch their pennies.

We have a broad debate in this country about how to approach consumer protection and financial education. Should we try to teach people how to manage their money and protect themselves? Critics say it doesn’t work; most people will never learn, they argue. Or should we ask government to erect financial safeguards at every turn? That’s what the Consumer Financial Protection Bureau is doing, and without question it is helpful. But we’re better off if individuals know they have to protect themselves and are equipped to do so — and this report suggests that’s a realistic goal.

(MORE: They’re Baaack: Americans Paid $31.6 Billion in Overdraft Fees in 2011 — and the CFPB Ain’t Happy)