As the election cycle commences, one would think that President Biden would be occupied with urgent matters. This is why I am perplexed by what his administration proposed. A couple of weeks ago, the Consumer Financial Protection Bureau (CFPB) announced a rule proposal that would close a loophole on bank overdraft fees. Yet it makes sense as an election move. While inflation is not what it was in 2021-22, inflation is still on the minds of the American people since consumer prices have not decreased to pre-2020 levels. The Biden administration attacking bank overdraft fees could be seen Biden fighting against price increases. Biden went as far as calling overdraft fees exploitation. Calling a policy exploitation is nothing new. It is a saying that has been made against sweatshops, donating one's organs for pay, price gouging, and privatized fisheries. Karl Marx believed that success was inherently exploitative. As nice of a sound byte as it makes, Biden's critique sidesteps the purpose of overdraft fees and basic economics.
An overdraft takes place when there are insufficient funds in an account to cover a payment or withdrawal. It is the extension of credit from the bank to the customer. The interest for this loan typically comes in the form of a one-time fee per overdraft. As I have brought up before, banks are financial institutions, which means their business literally is money. The fee helps a bank cover the payments that would otherwise be rejected. What would happen if an overdraft fee cap were to be imposed?
First, we should ask what the purpose of overdraft fees. Yes, the overdraft fee provides the bank with a source of income. However, the primary function of overdraft fees is to lower and offset the risks of lending. Overdraft fees provide an incentive to not spend more than you have, much like late fees on credit cards provide an incentive to pay credit card bills on time.
This is because instead of simply charging the fee on an ad hoc basis, it could mean shutting down the services completely, especially for those banking at smaller banks. A research paper from the New York Federal Reserve had the following to say (Dlugosz et al., 2023): "When constrained by fee caps, banks reduce overdraft coverage and deposit supply, causing more returned checks and a decline in account ownership among low-income households (p. 22)." This is not a call for exorbitant fees per se, but showing what happens when fee caps are imposed. What the research does show is that fee caps hamper financial inclusion for the people these caps are meant to help rather than enhance it. Even Biden's acting Comptroller of the Currency Michael Hsu warned that "limiting overdrafts may limit the financial capacity for those who need it the most."
We should ask ourselves what the alternative is if the banks get hit with an overdraft fee cap. Much like with what employers doing with minimum wage laws, banks can find a workaround to circumvent the fee cap. The banks could increase other fees. Banks could also remove such offerings as low-cost checking accounts or travel rewards. As previously mentioned, removing an option such as low-cost checking accounts could lead to more unbanked individuals. Why?
An overdraft fee cap is an example of a price control, which is something that proponents readily admit. I have talked about price controls before, whether it is consumer loan interest rate caps, rent control, drug pricing, price gouging, or fixed exchange rates. A price control below the equilibrium point, much like an overdraft fee cap, creates a shortage because the demand exceeds the supply. The shortage exists because some banks do not have the luxury of reducing or eliminating their overdraft fees.
The Left-leaning Brookings Institution points out that it is smaller banks in particular that make the bulk of their profits from their overdraft fees (Klein, 2021). This leads to a valid point that the Cleveland Reserve Bank brings up in its research on the unbanked (Boel and Zimmerman, 2022). While overdraft fees exclude some from the system, the overdraft fees also provide the revenue stream to make low-balance accounts more profitable. This is all the more so for smaller banks. Banks are more incentivized to open accounts for a wider range of customers, including low-income households, when they have this revenue stream. It would explain how overdraft fees help lead to greater financial inclusion of lower-income households on net.
Much like it is with landlords, it is politically expedient to malign banks, regardless of what they have actually done. What needs to be recognized is that banks are for-profit entities. If they continue to operate at a loss, they cannot stay in business. Banks thus have to make decisions as to whether it is worth it to have smaller accounts with smaller overdraft fees. Some of them decide it is not worth it, hence the shortage that price controls cause. At best, an overdraft fee cap is asking customers with stable finances to subsidize higher-risk customers. At worst, such a shortage can drive low-income households to such sub-optimal options as payday loans, pawn shops, loan sharks, or taking out a second mortgage on their home. This unfortunate phenomenon has been observed with consumer loan interest caps.
These arguments also need to consider the market trend of overdraft fees. Overdraft fees have been on the decline, from $30.9 billion in 2008 to $12.1 billion in 2023. With the rhetoric on the Far Left, you would think that banks only care about greed and lining their pockets by exploiting the working man more and more. So why the historical decline in overdraft fees?
To quote the St. Louis Federal Reserve, "Competition, from other banks and nonbank providers such as fintech firms, arguably have affected overdraft practices more than anything else." This competitive pressure can incentivize banks to restructure how it approaches these fees. There have been multiple banks that have either eliminated or reduced their overdraft fees without government intervention, including Bank of America, BMO Harris, Capital One, Citibank, and PNC Bank. The bank Vero allows for up to $50 in overdraft and automatically takes that loaned money back when the customer adds more funds to their account.
As long as fraud is not occurring and people can freely opt into overdraft protection or other banking services, we do not need Biden's latest proposed rule when a competitive marketplace is already reducing overdraft fees. The most probable outcome of such a policy would be limiting the supply of financial services to lower-income households. An overdraft fee cap will only hurt the people it is supposed to help, which is a pattern with economic policies on the Left. Consumers should not have to suffer simply because the President wants to score political points in an election year.
No comments:
Post a Comment