A costly courtesy: overdraft privilege

Besides being illegal, bouncing a check is costly. Customers face combined charges from banks and retailers that often total $60 or more.

In recent years, banks have helped customers avoid such consequences by offering overdraft protection - and, more recently, overdraft privilege - selectively covering checks that would otherwise bounce.

But some consumer groups say more recent versions of this program encourage customers to overdraw their checking accounts, generating millions of dollars in fees for banks. More than 1,000 banks offer some variation of overdraft privilege. Many banks also allow customers to overdraw accounts with ATM and debit-card transactions.

Banks contend that these services help customers avoid embarrassment, bad credit ratings, and returned-check fees from retailers. But critics view these programs as mere profit-generators for banks, often forcing customers into the equivalent of high-interest loans.

"Many of these programs encourage you to borrow money from the bank without disclosing the costs or setting up a reasonable repayment schedule," says Jean Ann Fox, director of consumer protection for the Consumer Federation of America. "Often, it's not even something that customers agree to. It's an automatic courtesy extended by the bank."

Consumer groups are urging the Federal Reserve to stop banks from providing overdraft privilege unless they abide by "truth in lending" laws and have a customer's written consent.

"If the Fed doesn't rein in it, then there are going to be big problems," says John Caskey, an economics professor and banking expert at Swarthmore College in Swarthmore, Pa.

Overdraft privilege was introduced in the mid-1990s and marked a major shift in the banking industry. While overdraft lines of credit had long been offered to favored customers, these newer programs target customers living from paycheck to paycheck. Overdraft fees are more expensive and restrictive than those charged to wealthy customers. While some programs charge a single flat fee of $25 to $35 for each overdraft, other banks impose daily fees until the account balance is out of the red. These fees can exceed what amounts to a 1,000 percent loan on lines of credit of up to $1,000. As such, overdrafts have become an attractive source of profit for banks.

One consultant estimates banks can increase nonsufficient funds (NSF) income by 50 to 200 percent by offering these programs. "Bankers are looking for noninterest income to strengthen their bottom lines in this soft economy, where lending has been reduced and profit margins have almost disappeared," says John Floyd, chief executive of John M. Floyd & Associates, an overdraft-privilege programs vendor in Baytown, Texas.

Some banks market the programs via brochures or on websites, reassuring customers that bounced checks will be covered. The fine print typically reserves the right not to pay a check, skirting any "truth in lending" issues.

For example, FirstBank in Kansas tells customers who have made honest mistakes in their checkbooks, run a little short on cash, or are faced with unexpected expenses to "relax... you deserve consideration." Wainwright Bank in Massachusetts uses the exact same language. But neither bank discloses the fees it charges for covering a bounced check, nor would bank officials return calls seeking comment.

But Diane Casey-Landry, the president of America's Community Bankers in Washington, D.C., insists that full disclosure is made to consumers and that ignorance of the rules is no excuse.

"If a bank sends you a letter telling you that it has changed your account, then it has given you all the disclosures and notifications and done its job," says Ms. Casey-Landry. "Customers have a responsibility to read the correspondence that comes from the bank."

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