The great overdraft debate has focused on fees. And as the pandemic began to wreak havoc on consumers, some financial institutions moved quickly to proactively address consumer complaints about overdrafts—especially those that regulators have identified as a legislative focus. With so many “fee free” programs in motion, we’re faced with a new question: Is reducing or eliminating fees really enough to change the overdraft game?

However you look at it, the answer is a resounding no. Why? Financial institutions have been focused on transparency only as it relates to overdraft fees themselves. They’ve made impressive progress in a short period of time—but they haven’t given consumers any way to resolve Non-Sufficient Funds (NSF) and overdraft transactions before they suffer negative consequences. They’ve only addressed how and when customers are charged.

Overdraft protection services don’t make customers aware of account shortages until after their financial institution decides which items were paid by an overdraft .  The consumer doesn’t get a chance to cover the account shortage before they incur negative consequences. Reducing overdraft fees might temporarily appease consumers and legislators, but it doesn’t deliver a better solution for overdraft.

Reducing or eliminating NSF fees is also fraught with issues. Regardless of how much is charged for NSF, every transaction posted to an account with insufficient funds is returned—subjecting the consumer to late fees and damage to their reputation and credit. There is no opportunity to resolve the issue before their rent check is returned. If this happens too frequently, they could become unbankable, which could lead to financial inclusion issues.

To satisfy complaints about fees, some financial institutions have done away with overdraft programs all together. This is a dangerous path to traverse from an economic perspective.

Eliminating overdrafts completely could hurt consumers—and the economy

Without overdrafts, the only way for consumers to avoid NSF is to meticulously track every transaction. While that was common practice years ago, the rise of debit cards and automatic payments (ACH) brought about the elimination of the check register. Add in the plethora of multiple subscriptions, recurring payments and digital wallets, and virtually no one keeps track of their detailed expenses.

Without overdraft protection in place, every shortage leads to NSF—overdrawn transactions simply won’t get paid. Consumers will be shocked when critical payments such as their rent bounces because their annual gym membership fee renewed automatically. Third party fees would pile up, and frustrations would fly high—especially if consumer credit scores begin tanking after missing multiple payments. Over time, consumers could face a situation where services like their utility company won’t let them pay online, they’d have to go to a service center and pay in cash. All because their streaming service increased its fee, they miscalculated how much their utility bill would cost that month, or a payment simply took an extra day to process.

The bottom line: Without overdraft, consumers will still face a plethora of fees. The only difference is they may not all originate from their financial institution—they’ll come from whoever they intended to pay, or from the payee’s financial institution. They face a lot more risk to their financial reputation.

Financial institutions can redefine the value of overdrafts

Regulators agree that eliminating or limiting overdrafts is not a consumer-friendly approach.  Even those financial institutions making progress in their overdraft offerings still have a long way to go to create fully “transparent and fair,” programs in the eyes of regulators such as the Consumer Financial Protection Bureau (CFPB) and the Office of the Comptroller of the Currency (OCC).

That’s because customers still aren’t notified in advance and don’t get a chance to rectify their overdrawn account before payments are returned. Consumers can’t make any changes to the decisions their institution makes about what is ultimately paid or not. Fees, if there are any, are still charged automatically, and often still apply per transaction.

The biggest risk in eliminating overdrafts is the possibility or consumers to become underbanked or unbankable, the opposite of what regulators are looking to achieve. A paper from the Consumer Financial Protection Bureau suggested that capping overdraft fees could cause banks to offer fewer affordable account options for low-income customers.

It’s not ideal for financial institutions,  as it opens up a range of financial risks, in addition to legislative and legal issues. Not all financial institutions can afford to do away with their fees. This model may work for larger banks, but overdraft fees contribute to a significant portion of non-interest revenue at smaller institutions. Without this income many may be forced out of business.

Giving consumers more control over transactions is consumer and regulator friendly

The financial industry needs to get ahead of the rapidly changing regulatory landscape by implementing straightforward, practical solutions to solve the overdraft problem. Eliminating overdrafts isn’t the answer. We should allow more consumer control in the overdraft process.

If consumers have insufficient funds to cover expenses , tell them immediately and give them a say in the matter. Enable them to cover that cost through another means—actively, in real-time. This takes what was a penalty and now creates a value-added service. This could come with a service charge, but the consumer becomes an active participant  by choosing if they want to use the service to override their financial institution’s decisions about transactions getting paid or returned. They don’t have to use it — keeping the financial institution’s default decisions and paying nothing. Consumer empowerment is the rising tide that lifts all boats. As consumers have access to more options and control, financial institutions deliver more value and mitigate legislative and legal risks. .

Significant progress has been made on the overdraft issue , but in order to truly deliver on the promise of consumer protection we need to empower bank and credit union customers to take control of their finances in the most up front, transparent and fair way possible. To do that, financial institutions need to look beyond overhauling overdraft fees to re-examine the value these programs deliver—and make sure consumers truly understand what they’re getting.

About Author:

Joel Schwartz is the Founder & Co-Chief Executive Officer of DoubleCheck Solutions, a financial technology company with an innovative solution that delivers new revenue for Financial Institutions while giving customers and small businesses more transparency and control in the event of Non-Sufficient Funds (NSF).

Joel spent more than 20 years as a banking executive, serving as a Senior Vice President and Regional Manager at First Bank and a Branch and Cluster Manager for Downey Savings. For over a decade, Joel taught Niche Marketing and Market Share Growth at UCLA Extension. His experience enabled him to see the need for a company that empowers customers to make their own financial choices, build a great credit score and protect themselves from fraud. To meet this need, Joel founded DoubleCheck in Burbank, California in 2013. The company is now poised to help banks and credit unions rethink the industry’s outdated banking practices in the face of unprecedented economic, regulatory and legal challenges.

Joel earned a bachelor’s degree in business administration and finance from San Diego State University.