LAKE FOREST, Ill.—Credit unions that continue to adhere to a “dated” practice are beginning to lose overdraft revenue as a result, asserts one analyst.
“In the past 20 years, overdraft volume for all financial institutions has consistently exceeded one-billion transactions. In the same time period, overdraft revenue has increased a total of $14.8 billion, or a 2.5% year-to-year increase, to $33.3 billion,” said Michael Moebs, economist and CEO at Moebs $ervices. “So, why is overdraft revenue falling for some depositories?”
According to the Moebs Overdraft Survey of more than 3,800 depositories in the first quarter of 2017, overdraft limits have not changed in 20 years. The median amount a checking account is allowed to be overdrawn has remained at $500 since 1998, explained Moebs.
“As an Industry, OD transaction volume and revenue may show an increase. However, at a depository level, restricting the overdraft limit to no more than $500 per account, will cause a loss in net revenue,” noted Moebs. “Applying classical economic principles, the overdraft limit drives overdraft volume. In simpler terms, a lower OD limit of $500 restricts the number of transactions incurred and will therefore cap the amount of potential revenue. A higher overdraft limit of $1,500 will allow more transaction volume to flow through the account and boost revenue.”
OD Revenue 'Elastic'
Another economic factor impacting overdraft revenue is price, said Moebs.
“The overdraft price has become elastic, where a low OD price drives more volume, and a high overdraft price generates less volume,” said Moebs. “What we see happening to many depositories is the high OD prices alongside the restricted OD limit is creating an accelerated decline in ovedraft revenue.”
Michael Moebs, Moebs $ervices
Less than 10% of all financial institutions offer a meaningful overdraft limit of at least $1,500 or more, said Moebs. Those depositories with higher limits have been experiencing increases in net revenue. The higher overdraft limits have also shown strength since the Great Recession started in 2008 and the passage of the Dodd-Frank Act in 2010, said Moebs.
“Ultimately, the biggest issue with higher limits is the risk involved. Most lenders view an overdrawn balance in a checking account as unsecured credit, with no collateral to protect the unsecured amount. This is a justifiable concern unless the overdrawn balance is paid back quickly,” said Moebs. “An industry benchmark shows that the principal overdraft losses are written off at a rate of about 10% of gross overdraft revenue with higher or lower limits.”
Some depositories have learned to incorporate automated decisioning and FICO scores to substantially reduce the risk of an overdraft, added Moebs.
“Using these credit tools appropriately to manage risk and allow depositories to offer higher overdraft limits will result in controlled losses related to revenue,” he said.
Three Points
Moebs shared three key “takeaways” regarding overdraft limits:
- Limits need to reflect the risk of the checking account user.
- Multiple limits may be used reflecting lower limits for high-risk users and higher limits for low-risk users.
- The limit must consider the average cost of living expenses of the user.
“It is important overdraft limits do not curtail volume but only risk as necessary,” said Moebs.