Morrison & Foerster Discusses Proposed CFPB Rules on Bank Fees

As part of its ongoing attack on bank fees, the Consumer Financial Protection Bureau (CFPB) has issued two proposed rules to regulate fees charged by banks: one on overdraft services, and one on nonsufficient funds fees. The proposed overdraft regulations would dramatically change the way overdraft services are provided by certain banks, limiting traditional “courtesy” overdraft fees to the bank’s cost or a low fee cap, and requiring banks to treat more profitable overdraft services like the provision of credit. The proposed rule on nonsufficient funds fees would prohibit such fees on real-time or near-real-time transactions.

First, on January 17, 2024, the CFPB issued a proposed rule that would change the way Regulation E and Regulation Z regulate overdraft services offered by the largest financial institutions (the “OD Proposal”). The OD Proposal would distinguish between overdraft services that are exempt “courtesy” overdraft services, subject to fee limitations determined by the CFPB, and overdraft services that are subject to requirements under the Truth in Lending Act (TILA) and Regulation Z.

For courtesy overdraft services, the OD Proposal would allow covered financial institutions to either (1) charge fees that cover the costs incurred when providing overdraft services (i.e., the “breakeven” fee) or (2) comply with a fee cap (i.e., the “benchmark” fee) determined by the CFPB. The OD proposal would allow higher-priced overdraft services—which would fall outside the “courtesy” exception—but would require them to be treated as credit and would apply Regulation Z disclosure and other requirements to them.

The OD Proposal would apply to insured financial institutions with more than $10 billion in assets. The CFPB indicated that it will monitor the market’s response to the OD Proposal before deciding whether to extend these restrictions to financial institutions with assets less than or equal to $10 billion.

Next, on January 24, 2024, the CFPB issued a proposed rule to regulate the charging of nonsufficient funds (NSF) fees (the “NSF Fees Proposal”). The NSF Fees Proposal would prohibit NSF fees on transactions that are declined either instantaneously or near-instantaneously, meaning transactions which are “declined without a significant delay after the transaction is initiated by the consumer.” Under the NSF Fees Proposal, charging NSF fees in such circumstances would be considered an abusive practice under the Consumer Financial Protection Act (CFPA).

In its press release, the CFPB acknowledged that financial institutions “almost never charge fees for transactions that are declined in real time” and that the agency “is taking proactive steps to ensure that financial institutions do not impose these fees.” The NSF Fees Proposal would apply to a “financial institution” as defined in Regulation E. Unlike the OD Proposal, the NSF Fees Proposal, if finalized as proposed, will apply to all financial institutions that offer consumer accounts—not just those with assets over $10 billion.

The CFPB ’s Slow March on Overdraft Services

Historically, based on an interpretation of TILA by the Federal Reserve Board, overdraft services were generally exempt from Regulation Z if consumers previously agreed in writing to the fees they would be charged. Despite the long-standing exception under Regulation Z, over time, the CFPB has shown an increased interest in overdraft services and the financial institutions that offer these services to consumers, including in the supervisory and enforcement context.

In 2017, the CFPB released a study that highlighted how expensive overdraft protection can be for consumers. In the years that followed, and as recently as last month, the CFPB entered into consent orders with numerous financial institutions where million-dollar fines were imposed by the CFPB in relation to the institutions’ overdraft practices. The CFPB also issued another report on Overdraft and Nonsufficient Fund Fees last month which provided insight into the extent to which overdraft protection is utilized and understood by consumers. The study reported that nearly a quarter of consumers surveyed lived in a household that was charged an overdraft fee in the past year.

The agency’s long-standing focus on overdraft services has culminated in this overdraft rulemaking.

Proposed Treatment of Courtesy Overdraft Services

Breakeven Fees

According to the CFPB, a covered financial institution would be able to charge a breakeven fee for providing overdraft services as a courtesy so long as the amount is equivalent to the financial institution’s own direct costs and charge-off losses related to the provision of overdraft services.

Under the OD Proposal, a covered financial institution would determine whether an overdraft fee is “above breakeven overdraft credit” if the “charge or combination of charges” exceeds the greater of: (1) the pro rata share of the covered financial institution’s annual total direct costs and charge-off losses related to providing overdraft services; or (2) an estimate to be published by the CFPB.

To use the breakeven fee approach, a covered financial institution would have to determine its total direct costs and charge-off losses for providing non-covered overdraft credit to all accounts open at any point during the previous 12 months and then divide that figure by the total number of non-covered overdraft transactions attributable to those accounts occurring within the previous 12 months. However, the CFPB made clear that certain kinds of costs should not be included in the calculation of costs under the breakeven standard (e.g., general overhead costs and charge-off losses resulting from, for example, unauthorized use and billing errors).

Benchmark Fees

Under the OD Proposal, the CFPB considers four options for the benchmark fee ($3, $6, $7, and $14). The alternatives each use the same general formula, but they use different reasoning and different data points. Generally, the CFPB determined total charge-off losses, excluding certain losses (e.g., losses attributable to unauthorized use and billing errors), and then added $1 to the charge-off loss per transaction calculation to account for a financial institution’s cost of funds and operational costs.

At a summary level:

  • The $3 benchmark fee is based on charge-off loss per transaction for the five financial institutions in the CFPB’s sample;
  • The $6 benchmark fee is based on the same sample data, but when calculating the charge-off loss per transaction, this alternative considered only non-covered overdraft transactions that resulted in an overdraft fee;
  • The $7 benchmark fee is based on charge-off losses for the financial institution in the sample with the highest charge-off losses; and
  • The $14 benchmark fee, which uses the same approach as the $7 benchmark fee, but (like the $6 benchmark fee) considered only non-covered overdraft transactions that resulted in an overdraft fee.

Proposed Application of Regulation Z to Higher-Priced Overdraft Services

Under the OD Proposal, overdraft services with fees that exceed either the breakeven fee or the benchmark fee would be considered credit under Regulation Z, and would be subject to a new Section 1026.62. The OD Proposal refers to these overdraft services as “covered overdraft credit.” A covered financial institution charging such fees would be required to: (1) establish a credit account for the customer (separate from the customer’s asset account); and (2) comply with Regulation Z, including the requirement to provide account opening disclosures and periodic statements to consumers, the prohibition on offsets, the requirement to disclose credit limits, and the limitations on penalty fees and fees charged during the first year after account opening. There are important questions about the suitability of credit card protections for overdraft services and the ways in which consumers use these services.

Treating covered overdraft credit as credit under Regulation Z would impose a variety of new obligations on financial institutions. In the supplementary information to the OD Proposal, the CFPB states that consumers will benefit from receiving Regulation Z disclosures both because they will be able to understand the contractual terms of overdraft credit and because they will be able to compare the cost of overdraft credit with that of other credit products. If the OD Proposal is finalized as proposed, financial institutions that offer covered overdraft credit would be required to provide consumers with account opening disclosures. Account opening disclosures require financial institutions to provide a variety of information, including the annual percentage rate, balance computation method, and amount of late payment fees. In the OD Proposal, the CFPB makes clear that account opening disclosures would have to be provided to consumers on the day a consumer has a transaction that is covered by overdraft credit.

Moreover, if subject to Regulation Z, financial institutions will need to change the way in which consumers reimburse them for overdrafted funds. Currently, after a consumer receives overdraft protection, financial institutions will often be reimbursed for the overdraft balance when a consumer makes a deposit in their bank account. However, this practice of “offsetting” a consumer’s account is prohibited by Regulation Z. Accordingly, financial institutions would not be able to immediately recoup overdrafted funds once a consumer has sufficient funds in their bank account. Instead, when a consumer makes a new deposit into their bank account, financial institutions would have to credit the funds to a consumer’s account, which would allow the consumer to use the funds, before the financial institution is able to recover the amount extended for overdraft.

These highlighted requirements are among the many new obligations that would be imposed on financial institutions that offer covered overdraft credit to consumers.

The CFPB’s Ex Post Facto Focus on NSF Fees

Like overdraft fees, the CFPB has focused on financial institution assessments of NSF fees. In the CFPB’s December 2023 Overdraft and Nonsufficient Fund Fees Report, the CFPB noted that one in five consumers lived in a household where at least one NSF fee was charged. The CFPB acknowledged, however, that many financial institutions have already substantially eliminated NSF fees. Specifically, in October 2023, the CFPB noted that 97% of NSF fees had been eliminated by financial institutions with over $10 billion in assets. The CFPB also noted that the elimination of NSF fees will save consumers over $2 billion annually. According to the CFPB, many credit unions do still charge NSF fees, though, a fact that the CFPB highlighted both in its 2023 study and in the NSF Fees Proposal.

Prohibition on NSF Fees for Transactions Authorized or Approved in Real Time

Under the NSF Fees Proposal, NSF fees would be prohibited on transactions made through any method so long as those transactions are instantaneously declined (e.g., debit card, ATM, person-to-person). However, the NSF Fees Proposal would not prohibit financial institutions from charging NSF fees on checks and ACH transactions because payments made through these methods are not declined either instantaneously or near-instantaneously.

In its proposal, the CFPB indicates that such NSF fees are abusive because consumers lack a material understanding of the risks, costs and conditions when they initiate a transaction that will result in an NSF fee. The CFPB claims that consumers lack a material understanding of the risks, costs, and conditions associated with NSF fees in part because consumers are paying a fee but receiving no benefit in return. Moreover, the CFPB claims that the charging of NSF fees is abusive because financial institutions have no reason to impose these fees other than to generate revenue. Instead, the CFPB indicates that financial institutions can simply refuse to authorize a transaction, which would result in an insignificant cost. Lastly, the CFPB claims that NSF fees are abusive because they allow financial institutions to succeed as a result of a negative consumer outcome.

What’s Next?

The OD Proposal and NSF Fees Proposal continue the CFPB’s attack on bank fees. We expect that these proposals will be followed by a final rule on credit card late payment fees.

If the OD Proposal is finalized as proposed, it may cause some financial institutions to change existing overdraft practices. Many financial institutions have already made these changes voluntarily, however, with over a dozen large financial institutions either reducing overdraft fees or eliminating them altogether. Accordingly, while the OD Proposal, if finalized, could have a significant impact on financial institutions that still offer covered overdraft credit services, the OD Proposal will not have the same impact on the industry that it would have five years ago. If the NSF Fees Proposal takes effect, it would likely have an even smaller impact on financial institutions than the OD Proposal.

Comments on the OD Proposal are due April 1, 2024. The CFPB expects the final rule to take effect October 1, 2025. Comments on the NSF Fees Proposal are due by March 25, 2024. The CFPB expects the final rule to take effect 30 days after the final rule is published.

This post comes to us from Morrison & Foerster LLP. It is based on the firm’s memorandum, “CFPB Continues to Challenge Bank Fees: CFPB Issues Proposals to Regulate Overdraft Services and to Prohibit NSF Fees,” dated January 29, 2024, and available here.