Mixed and Matched: Sorting out which regulations apply to particular consumer overdraft protection programs

Check bounce programs, cash sweep programs and payment lines of credit—each brings a different set of regulatory requirements, policies, procedures and practices.

In addition to federal laws and regulations, the federal bank regulatory agencies have issued two policy documents that remain the principal sources of guidance on their expectations for overdraft programs. In February 2005, the Federal Reserve released guidance on overdraft protection programs, Joint Guidance on Overdraft Protection Programs. In November 2010, following an extensive study of overdraft payment programs, the FDIC published FIL-81-2010 Overdraft Payment Programs and Consumer Protection Final Overdraft Payment Supervisory Guidance

Then, most recently, in February 2012 the Consumer Financial Protection Bureau launched an inquiry into checking account overdraft programs to determine how industry practices affect consumers. The comment period for the inquiry closed in June 2012. The bureau’s findings have not yet been published; however, it is expected that additional guidance will result.

Overdraft program options

Community banks generally use three types of arrangements to cover account overdrafts. The first is a true line of credit that requires credit approval, and an agreement exists for the bank to transfer an overdraft balance to the credit line. The credit line is subject to the Truth in Lending Act, and the terms and conditions are agreed upon in advance by both parties.

The next type of overdraft program is what is usually called a sweep-account arrangement. In this case, the bank agrees with the account holder to “sweep” funds from another account owned by the customer, typically involving funds on deposit in an interest-bearing account. This arrangement does not create a loan because the funds used to cover the overdraft are already on deposit at the bank.

The third type of overdraft coverage community banks offer is an overdraft protection program, also called an ad hoc program, or “bounce protection” program. For this type of account, banks typically disclose the availability of the bounce protection program in the disclosures presented at account opening. If the accountholder doesn’t execute an opt-out provision, the protection becomes effective when the account meets the program’s guidelines, such as the account’s balance or the number or amount of deposits made. For bounce protection, the bank usually makes a decision on paying items as they are presented.

Although each overdraft creates a “loan” from the bank to the account holder, these programs are not covered by a loan agreement, and financial institutions reserve the right to pay or not pay an item. Bounce programs are not subject to Regulation Z. A non-sufficient funds fee may apply for each item presented. That fee would generally be charged whether the item was paid or returned. Many banks contact the account holder and require that the item be covered within a specified timeframe. These programs are convenient for account holders and generate valuable and legitimate service fee income for banks.

Lastly, although not common for community banks, some institutions use an automated overdraft payment program. A sort of check bounce-protection program, this program runs on predetermined criteria without involving bank employees. Automated overdraft payment programs are the focus of the FDIC’s 2010 guidance, which emphasizes that the FDIC expects the institutions it supervises to implement effective compliance and risk management systems for automated overdraft payment programs.

An automated overdraft payment program is a variation of a bounce program and typically includes the following characteristics:

Rules and best practices

Banks not directly supervised by the FDIC should still look to the 2010 guidance as industry “best practices.” Some recommendations from the guidance are:

Let’s take a look at these four types of consumer account overdraft programs—overdraft lines of credit, sweep programs, bound programs and automated overdraft programs—and a short summary of the regulatory requirements that apply to each.

Overdraft lines of credit

Sweep overdraft program

Bounce programs

Automated overdraft program

Your community bank’s management should ensure that all of its overdraft payment and line-of-credit practices conform to all applicable laws and regulations. Following the agencies’ guidance and building appropriate regulatory checks into your bank’s compliance program will mitigate safety and compliance risks, and reduce the possibility of violations.

Mary Thorson  is vice president of Chartwell Compliance, an ICBA Compliance & Risk Management service provider.


Please wait...

Subscribe to our Technical Publication!

Want to be notified when Compass is published? Enter your email address and name below and sign up to our mailing list!
Please wait...

Download the PDF File