February 2024 OBA Legal Briefs

• CFPB Proposes New NSF Fee Rule
• Overdrafts — Comments Requested

Editor’s Note: We do not usually write about proposed rules in Legal Briefs because so much can change between publication of a proposal and issuance of a final rule. However, we believe that Oklahoma’s bankers need to know about both of the recent CFPB proposals discussed in this edition.

CFPB Proposes New NSF Fee Rule

By John Burnett

On January 24, 2024, The Consumer Financial Protection Bureau announced a proposal for a new regulation on non-sufficient funds (NSF) fees. That should not have been a surprise, because the CFPB mentioned the possibility of a rule on NSF fees at least as long ago as 2022, when its Fall Regulatory Agenda indicated the Bureau was considering whether to issue new rules regarding them.

Now, the “other shoe” has dropped. Perhaps we should call it “a mismatched shoe,” because the new regulation proposal does not reference current financial institution practices regarding NSF fees. Instead, it anticipates that a bank or credit union might just be looking for a new fee income source, and the Bureau proposes to “nip it in the bud” before the idea can become a reality.

In short, the Bureau wants to ban something that almost no one (that the Bureau knows of) practices, but someone might try in the future. Here is what the proposal is all about.

It happens all the time — Someone taps their debit card on a POS terminal at Walmart to pay for a cartload of groceries, and the terminal displays “denied” or provides some gentler negative response because the cardholder’s bank account isn’t up to the task, the well is dry, or, in banker-speak, the account balance is “non-sufficient,” and the bank will not approve a transaction that would overdraw the account. The same result can be seen at an ATM, and in some peer-to-peer transfer networks.

The Bureau thinks that there might be a bank, credit union, or P2P network out there looking for ways to replace some of the fee income it has given up (perhaps in the current campaign against “junk fees”), and counting the number of NSF responses it sends back on ATM, POS and transfer authorization requests to see if they might be leaving some fee income on the table.

So, in a remarkably short (only 68 pages in all, with just over one page devoted to the words of the regulation) Federal Register document, the Bureau has proposed as new regulation (Part 1042) to say, in essence, “Don’t you even THINK about doing that!” by borrowing the definitions of “account” and “covered financial institution” from Regulation E and defining a “covered transaction” as “an attempt by a consumer to withdraw, debit, pay, or transfer funds from their account that is declined instantaneously or near-instantaneously [sic] by a covered financial institution due to insufficient funds.”

That’s followed by a definition of “nonsufficient funds fee” as “a charge that is assessed by a covered financial institution for declining an attempt by a consumer to withdraw, debit, pay, or transfer funds from their account due to insufficient funds” regardless of how the financial institution labels the fee. Then the proposed rule declares the charging of such a fee to be an abusive practice and prohibits it. A short little regulation with three little sections, about 270 words (including headings), and no official interpretations (as proposed).

I will not ask whether your bank has been thinking about imposing these “real-time” NSF fees, or whether, after reading the proposed rule, your bank changed its mind.

Comments are due by March 25, 2024. If you have a comment to offer, check out the guidance for commenters at the end of Andy’s article below.

Overdrafts – Comments Requested

By Andy Zavoina

In late 2023 there were a reported 4,645 commercial banks, 574 savings and loan associations and 4,994 credit unions in the United States. That is 10,213 financial institutions if you do not want to do the math. This gives you an idea of the “universe” which can be impacted by a new rule or interpretation. But some rules and interpretations do not actually affect all financial institutions.

When a new proposal or rule is published, the first things I would do is determine the impact of the proposal on my bank based on a general description, and if it will apply to me, when is it going to be effective? Well, on January 17, 2024, the CFPB released its proposal to “close the overdraft loophole that costs Americans billions each year in junk fees.” How will it accomplish this? With a tweak of a few words in a few regulations in certain conditions overdraft fees will be considered finance charges under Reg Z and Truth in Lending. Now my head begins to spin as I fear making APR disclosures, usury limits, periodic statements and those things associated with loan closings and lines of credit. But am I getting ahead of myself? To be clear, this rule will impact only the largest banks, those at or over $10 billion in assets.

If your bank is not in that category, please DO NOT STOP reading now and move on to more meaningful issues affecting your bank. While the CFPB estimates only 175 financial institutions will be impacted, and the math tells us that this amounts to a mere 1.71 percent of all financial institutions, there are some people who believe this rule could trickle down to smaller, community banks. According to the FDIC, Oklahoma has 178 banks with main offices in Oklahoma. Only a small percentage of these will be in the larger bank category and subject to the new rule, when and if approved.

Think about the process involved in a Notice of Proposed Rulemaking (NPRM). A proposal is made, and comments are requested. In a proposal that will relieve the American public of paying “billions of dollars” each year in non-sufficient funds – junk fees – charged by “banks” (meaning the financial institutions referenced above) where will the comment letters in support of, and against, all or some of the proposed rule come from? Will more come from the consumer protection organizations and the American public, or from those 175 banks? And will the final rule indicate overwhelming support for the proposal based on the comment letters, or that thoughtful comments indicated that overdraft fees are not always bad, these serve a purpose, and help in controlling fees in general charged by banks, they act as a deterrent for writing bad checks and should not be mischaracterized as “junk fees.” Would you be surprised to read that “based on overwhelming support of the proposal” it is approved? And do not forget the political aspects of this in an election year. The president and his staff have dwelled on junk fees and the large dollars collected by banks from consumers.

I want to explore the concept of “consumer protections” and the intent of these rules and contrast this to rules applicable to larger banks as compared to smaller banks. Using the Home Mortgage Disclosure Act (HMDA) as an example, when reporting is limited to larger institutions, the amount of data gathered is proportional to the size of those lending institutions. By limiting the application of the rule to the larger volume lenders the public gets the vast majority of the lending data gathered. Having such a rule excluding the smaller lenders makes review and analysis of trends much easier and it is cost effective, especially for those smaller lenders who have the same data gathering burden but far few resources and less technology to meet the requirements. Having the smaller lenders exempt from reporting takes away little data. In years past the CFPB did increase the reporting threshold for HMDA applicable loans. This increased the number of exempt lenders and therefore took away a small amount of data. It worked just as planned. The public and regulatory agencies received useful data and the smaller lenders were able to still make loans supporting the housing efforts of their communities yet deploy funds and assets elsewhere to facilitate an overall more effective community bank.

But no good deed goes unpunished. There was a court case which argued that data was necessary to properly evaluate the housing efforts of even the smaller lenders and the action was successful. The argument that less data still accomplished the goals of HMDA was not enough and the CFPB did not appeal the decision. The threshold dropped to its prior limit. Now a larger segment of smaller volume lenders is once again recording and reporting HMDA information. My point is, the objectives were met even with the higher limit, but the argument that a more microscopic application better meets the needs for more finite reviews prevailed. At the end of the day, consumer protections against discrimination were deemed better met by applying the rules uniformly down to smaller lenders and eliminating only the smallest of low-volume lenders.

Contrast this HMDA example to a true consumer protection regulation. The former is based on a bulk of transactions and analysis using a broad brush, and the latter is based on individual transactions. The overview of the proposed overdraft fee rule includes three important points.

1. The proposal would require very large banks to treat commonly used overdraft protection as credit, making it subject to Reg Z disclosure requirements and other protections that apply to credit cards and loans.
2. The proposed rule provides those banks subject to the rule two options on how to approach handling overdrafts. The bank could offer overdraft loans, officially offering lines of credit and triggering a multitude of disclosures and statements (e., processing) meaning potentially systems improvements and all that comes with such an undertaking. Alternatively, the bank could offer overdrafts as a courtesy service where fees do not exceed costs and losses, using a “breakeven standard” calculation or, optionally, a “benchmark fee.” Currently these benchmark fees being proposed are $3, $6, $7, or $14. The CFPB estimates the average fee is currently $35.
3. The new rules would apply to banks and credit unions with $10 billion or more in assets and, if finalized as proposed, would go into effect in October 2025. That provides nearly two years to prepare from the publication of the NPRM.

Under a data gathering rule, there is the broad brush used to effect protections and these take extended periods to provide substantive information to act on. In this proposal it is individual transactions which will be impacted. Which is truly the most effective form of consumer protection? There is no denying that individuals who are protected at each transaction receive the most benefit and more quickly than is derived from data which takes years to accumulate and analyze. How can any regulatory agency that is responsible for consumer protection actions justify applying such a rule based on the asset size of the lender when all banks are subject to Reg Z already? A depositor with an overdraft at a smaller community bank would not be entitled to the same protections afforded a similar consumer at a larger bank even when both banks are subject to the same regulation that provides the protections.

If you are keeping a tally of the impact this rule poses and are comforted by the fact that your bank is under the $10 billion threshold, do not take that sigh of relief too soon. The CFPB has hinted at potentially applying this rule to smaller banks, stating that the CFPB intends to “monitor the market’s response” before deciding whether to expand the scope to smaller banks in the future. In the future it would be quite easy to justify expanding this proposal to all banks.

I ask you, what is the “market’s response” to this proposal if fewer than 175 banks comment? Certainly, banking organizations will respond but I would add that thoughtful comments from the smaller and as of yet unaffected banks need to be made to better protect those who do not want the options described above in their future. I would add that once the larger banks have adapted to the new rule and vendors have worked through the technological hurdles, it will be deemed a much easier process for smaller banks to adopt the same rules.

As a brief background, Congress gave us the TILA in 1969 and the Federal Reserve then gave us Reg Z to implement it. As to the use of currency, checks were frequently used by consumers to send money and pay bills. Zelle and similar programs were not invented. Check volume was huge and growing annually. It was recognized at that time that check processing was labor intensive. The processing technologies banks have used for decades did not exist then. Checks were manually encoded, and the items were compared to account balances. They were typically manually reviewed, account analysis was completed, and someone made a decision to pay or return an item. The bank had policies that would have included considering how long the bank has had the account, the average deposit balance, when deposits were made (direct deposit was not required  or even highly encouraged until the 1970s) and how often the account had checks presented that exceeded the available balance. It was a costly and manually intensive process. The Fed exempted overdraft=related costs from Reg Z requirements if the bank honored a check when its depositor “inadvertently” overdrew their account. Over recent years banks have been careful not to confuse inadvertent overdrafts with lines of credit because the costs of disclosing the latter can be high and smaller banks may not even have the technology to meet the Reg Z disclosure requirements. Overdrafts were not nearly as frequent in 1969 as today, and banks imposed fees to cover these processing costs as well to incentivize the depositor to not overdraw their account.

Banking technology has come a long way, and these costs are now greatly reduced and may be deemed truly minimal, other than the costs of the technology used and the cost of funds. Reg Z has retained this exemption, but this is what is now being considered for removal. This intentional exemption is the loophole in question.

The loophole is in the definition of “finance charge” at 1026.4(c)(3). Paraphrasing from the NPRM, page 64, “These proposed changes require compliance with not only Reg Z when providing higher than breakeven overdraft credit services described below, but would allow those banks to continue to comply with Regs DD and E when providing non-covered overdraft credit services at or below breakeven pricing. This means the banks that have invested in compliance with Regs DD and E could maintain their current processes for providing consumers with non-covered overdraft credit so long as it priced such credit at or below breakeven pricing.” Reg E will require some tweaking as well to allow complete compliance with this proposal and as credit products, banks may start reporting these overdraft lines to credit bureaus.

Reg Z would have new key terms and definitions that would become commonplace in discussions as operations and lending bridge these overdraft gaps, terms like, overdraft credit, above breakeven overdraft credit, covered asset credit account, covered overdraft credit, covered overdraft credit account, and hybrid debit-credit card.

I also find it interesting that it is never mentioned that in most cases writing a check against non-sufficient funds is typically a misdemeanor, a crime. Neither banks nor regulatory agencies should encourage such an act. Providing both payment options, the approval of an inadvertent item and a line of credit cause the items to be paid rather than returned, avoiding misdemeanors and fees from those on the receiving ends of the checks. This protection ends when banks begin returning the items because they cannot pay the items due to cost inefficiencies. These inefficiencies will be based on the lower income derived from overdrafts, potentially increased costs due to losses and the cost of technology to support lines of credit if that is what banks opt to offer.

While banks can continue to provide courtesy overdraft credit as is often done now, the fees which will be regulated would be assessed against a breakeven calculation or a benchmark amount. If the fees are equal to or less than these metrics, the overdraft credit provided would not be subject to Reg Z. Using this low-cost approach will exempt the bank.

1. To use a breakeven standard the CFPB would require the bank to determine its total direct costs and charge-off losses for providing overdraft credit to all accounts open at any point during the previous 12 months. This amount would then be divided by the total number of overdraft transactions attributable to those accounts occurring in the previous 12 months. The proposal includes guidance on the types of costs and charge-off losses that a bank may consider when making this calculation.
2. The CFPB proposes to set this alternative fee, a breakeven fee at $3, $6, $7 or $14, and the Bureau believes this would create a “simple bright-line method” for the very large banks to use when assessing whether the overdraft credit they provide is below or above the breakeven threshold. The CFPB reached each of the benchmark fees by applying different calculations to relevant data collected from eight of the large banks.

The alternative to use of the breakeven or benchmark fees is overdraft lines of credit. Overdraft credit can be provided at a cost higher than the breakeven standard or the benchmark fees described above, but the cost to the bank is that these would be subject to Reg Z.

This compliance would require treating transfer fees (line of credit to overdrawn account) as finance charges, or the bank can eliminate those fees altogether. This line of credit then offers consumers a means of repaying their overdrafts other than by preauthorized EFTs. This line of credit facility also means compliance with the regulatory provisions in Reg Z that apply to credit cards that would newly apply to certain types of covered overdraft credit. This requires systems and new skillsets for your staff.

Banks would then be required to make mandatory disclosures to consumers disclosing the cost of credit and more. Hybrid debit-credit cards used by consumers to access overdraft credit would be subject under the proposal to the Credit Card Accountability Responsibility and Disclosure (CARD) Act-related sections of Reg Z. These would include, but are not limited to, ability-to-pay underwriting requirements and limitations on penalty fees.

The proposal also requires that overdraft credit be structured as a separate credit account, not a negative balance on a checking or other type of transaction account. The underlying checking or transaction account would be considered the asset account and tied to the separate credit account created for the overdraft credit. This separate credit facility would have its own due date at the same time for each period. That means that if a $100 item is paid on the first against a deposit balance of $40, the $60 goes to the credit facility. If a deposit of $100 to the deposit account is received on the second, there is no setoff available. The $60 owed is under the credit line and is not owed until the billing is due, possibly at the month end, as an example. The billing dates will have to be on the same day of each billing cycle.

The banks subject to the proposed new rule would also be prohibited from compelling consumers to use automatic payments to repay overdraft credit, which would effectively require them to provide consumers with at least one alternative repayment option.

One point I have not seen addressed yet includes those consumers subject to the Military Lending Act (MLA). The bank would need to know who these consumers are in order to meet the disclosure requirements of the MLA. Currently the MLA is moot. In the FAQs published in the Federal Register, Vol. 81, No. 166, Friday, August 26, 2016, under Section II, question 1, it asks, “What types of overdraft products are within the scope of 32 CFR 232.3(f) defining ‘‘consumer credit’’?” The answer includes, “The MLA regulation generally directs creditors to look to provisions of TILA and its implementing regulation, Regulation Z, in determining whether a product or service is considered “consumer credit” for purposes of the MLA. Also, the supplementary information to the July 2015 Final Rule discusses coverage of overdraft products.

The MLA regulation defines “consumer credit” as credit offered or extended to a covered borrower primarily for personal, family or household purposes that is either subject to a finance charge or payable by a written agreement in more than four installments, with some exceptions. The exceptions include “residential mortgage transactions; purchase-money credit for a vehicle or personal property that is secured by the purchased vehicle or personal property; certain transactions exempt from Regulation Z (not including transactions exempt under 12 CFR 1026.29); and credit extended to non-covered borrowers consistent with 32 CFR 232.5(b).”

If overdrafts are paid from a line of credit and are subject to Reg Z, in addition to the CARD Act and ATR, there will be MLA requirements. The bank will have to know if it is dealing with a covered borrower at the time the credit is offered. This includes dependents. There are written and oral disclosures required as well as a Military Annual Percentage Rate.

Most banks are aware of the “all in fee” nature that the MAPR has resulting in a higher rate than Reg Z APR. But the open-end MAPR is different still. From the CFPB exam manual — “…the MAPR for open-end credit should be calculated following the rules for calculating the effective APR for a billing cycle as set forth in 12 CFR 1026.14(c) and (d) of Regulation Z (as if a creditor must comply with that section) based on the charges listed above. Even if a fee is otherwise eligible to be excluded under 12 CFR 1026.14(c) and (d), the amount of charges related to opening, renewing, or continuing an account must be included in the calculation of the MAPR to the extent those charges are among those in the above Types of Fees to Include in MAPR Calculation.” While the MAPR will still be capped at 36 percent and presumably all the fees will be compliant and reasonable, the minimum fees will have to be weighed against the amount of the credit and the date of the payment due from the consumer. How close to 36 percent could possible scenarios get? When and how often will banks be required to verify with the DMDC database that their overdrawing consumers are covered or not?

There are many questions, and I believe that every banker who reads the 211-page proposal will ask themselves similar questions, but also a few unique ones. Comment letters that all banks are encouraged to submit should pose these questions so that guidance can be included in a final rule and not offered in the distant future when the questions are real and not hypothetical.

While this article is not intended to serve as a how-to on writing a comment letter, I am asking all banks with an interest in the overdraft topic now or in the future to seriously consider sending one. Therefore, I will include points common to comment letters though few comment letters would ever be considered wrongly sent.

1. Read the entire proposal to best understand the requirements and ask meaningful questions supported by realistic and factual scenarios to support them.
2. Where any questions are asked in the NPRM of those submitting comments, answer them. This increases the usefulness of the process especially in those which ask, “what is the impact of…” on a bank or consumer.
3. Use facts and refrain from personal comments such as “the proposal is unfair because…” or in this case, “the consumer wrote the check, and we disclosed the fee and that’s all that matters.” That would take the process nowhere and is often just subjective. Cite facts and conditions which support the bank’s position that this is a cost-effective option when considered overall. If more checks are being returned the consumer will suffer more costs, especially from merchants not obligated to keep fees low for returned payments, and for consumers who later find it harder to bank anywhere due to poor management of checking accounts in the past.
4. Specifically quote the proposal where appropriate so the reader knows exactly what your comment pertains to.
5. Some banking organizations may prepare comment letter templates. These are useful as to providing guidance on topics and formats. But the regurgitation verbatim of someone else’s comment letter is nothing better than a tick mark for, or against something as the comments have already been stated and read. It will add to support your position, but in a less meaningful way.
6. Offer suggestions on issues that are realistic and meet the goals of both your bank and the consumer’s needs for protection. After reading the proposal, you will read about issues such as, “For example, CFPB research found that in 2012 the median overdraft fee was $34, the median size of a debit card transaction incurring an overdraft fee was $24, and that the majority of non-covered overdraft credit transactions were repaid within three days. Putting these figures in lending terms, the annual percentage rate (APR) for such a non-covered overdraft credit transaction would be 17,000 percent (if transaction fees were included in the APR calculation).” This is where the cost to actually process a transaction comes into play, as well as losses and collection expenses. I see the APR as less of an issue when the fees are reasonable. It is not enough to say an APR is not reasonable when the actual fee is only a matter of a few dollars. Expressing that minimal fee as an annual rate provides an unbalanced calculation.
7. Balance your comment letter based on the bank’s experience as a whole. That is, consider the side of the loan department as well as operations for the big picture.
8. The pounds test is not a goal to be met here. Do not add comments that go on and on so that if printed, you will have the longer document. Succinct and meaningful comments that convey valid points will be held in higher regard as being productive for all. You don’t need to address every issue raised in the proposal. Focus on the elements most important to you and your bank.
9. If you read other comment letters or reports in the press, you will understand those who disagree with your position. With this understanding you can better offer intelligent counterpoints.
10. The comment period for this proposal ends April 1, 2024. You should have your letter in by that date. Sending it electronically is the fastest and easiest way to make a submission. Prior to sending yours, you can read others that have been submitted and remember your comment letter will also be publicly available. For this reason, bank management and/or counsel may want to be involved in the process. The NPRM itself contains instructions for all this.