By Christopher Leonard, Velocity Solutions CEO
The Consumer Financial Protection Bureau (CFPB) has proposed a rule to be effective October 1, 2025 (at the earliest) that would regulate overdraft services at financial institutions with $10 billion or more in assets.
Our business (Velocity Solutions) provides overdraft workflow management software to hundreds of financial institutions. We and our clients overwhelmingly view the CFPB’s action as positive confirmation that overdraft is here to stay, contrary to the narrative some are promoting in the financial press.
The proposed rule substantiates that the CFPB understands the importance of the critical liquidity function that overdraft provides for the people who need it most. Many studies have shown that consumers want overdraft, and current rules require financial institutions to obtain consumers’ affirmative consent before they can charge consumers an overdraft fee on everyday debit card transactions. Furthermore, overdraft has consistently represented less than 0.2% of the total complaints the CFPB receives.*
Overdraft fees need to be separated from functionality – the functionality of providing liquidity to consumers that need it is critical, while there is an ongoing debate about the fees.
Outline of the Rule
The essence of the proposed rule is that if a financial institution with over $10 billion in assets wants to continue to offer overdraft as it’s offered now, the overdraft fee can’t exceed the greater of (a) the cost to the institution of offering overdraft, or (b) a set dollar amount between $3 and $14 that the CFPB plans to finalize, which it believes approximates the cost of offering overdraft based on a very limited data set (5 banks).
If a financial institution with over $10 billion in assets doesn’t want to comply with the price controls, then it can offer overdraft as a credit product using the same underwriting required for credit cards.
What Will Happen if the Proposed Rule Becomes Effective?
Our clients with over $10 billion in assets are largely taking a wait-and-see approach given the potential legal challenges that could result in the rule being enjoined or struck down by a federal court. Most believe that making changes long before the rule’s earliest possible effective date (October 1, 2025) is not the right business decision, but they are thinking about how to be prepared.
If the proposed rule does go into effect and the safe harbor fee amount ends up being $14, we believe the overwhelming majority of financial institutions will continue offering overdraft. In fact, there are multiple large banks (BMO, Huntington, M&T and Santander) that already charge overdraft fees of $15.
If the safe harbor amount is lower than $14, then the net income from overdraft will become more of a focus than ever since top-line revenue will be under pressure. As a software company that provides ability-to-repay underwriting on overdraft, which helps protect consumers that cannot afford to repay overdrawn balances and helps financial institutions minimize charge-offs, we expect that our existing clients will ask us to adjust the parameters of our model to further reduce charge-off risk. That means these institutions would cover less transactions and ultimately reduce liquidity available to many of the consumers who need it the most. We also expect to see increased demand from larger institutions looking for software like ours because they will want to lower their charge-off rate.
Alternatively, large financial institutions could implement the CFPB’s option to move overdraft to a line of credit model. Velocity already has made automated small-dollar credit a key offering in our consumer liquidity software suite to meet this need, and most of the largest banks already have small-dollar lending alternatives in place.
Effects on Financial Institutions Under $10 Billion in Assets
The proposed rule only applies to financial institutions with more than $10 billion in assets. Most of our clients under $10 billion in assets have no plans to alter their overdraft pricing or programs. There has not been any clear evidence of overdraft fee amounts or policies impacting demand at these financial institutions, and we believe the proposed rule could be a tailwind to institutions under $10 billion in assets.
Smaller institutions with existing overdraft programs have the advantage of being able to continue to offer free checking accounts, given that many of them will continue to charge a higher overdraft fee than the CFPB safe harbor amount and use that income to subsidize costs for free accounts.
When consumers are shopping for a new checking account, smaller institutions will have a clear competitive advantage when consumers consider monthly account fees, since larger institutions will have to charge more of them and make it harder to waive them.
We also believe that the proposed rule will re-prioritize overdraft as a technology imperative for the thousands of financial institutions of all sizes which do not currently deploy an intelligent platform to manage it. Overdraft is here to stay, as is the regulatory and market focus on providing it efficiently, fairly and sustainably.
Unintended Consequences of the Proposed Rule
The CFPB proposed rule also would have secondary effects that harm the most vulnerable consumers by making the regulated banking system unaffordable for them.
As a Federal Reserve study found, “overdraft fee caps hamper, rather than foster, financial inclusion.” Ultimately, financial institutions make up lost overdraft income somewhere else, typically through higher monthly account fees and making it harder to get those fees waived (e.g., requiring a minimum checking balance of $1,500 instead of $500). Low-income consumers can’t afford hundreds of dollars a year to have a checking account, so many will become unbanked.
The Fed study also states that fee caps can be responsible for “rationing” of overdraft liquidity to riskier depositors. This is consistent with our discussions with clients, who would be looking to reduce risk through tightening our ability-to-repay underwriting should their top-line overdraft income come under pressure.
Many consumers using overdraft are credit invisible or unscorable, so overdraft is likely to be their only option within the regulated banking system. Without overdraft coverage, they will turn to payday lenders, pawn shops or other alternatives outside of the banking system, which have their own set of potential consumer harms and could result in much worse financial outcomes.
Focus on Fairness
Velocity has advocated for greater fairness in overdraft for many years, just as the CFPB has. The reality is that financial institutions have responded positively to this call to action without the need for regulation.
Of the top 20 banks the CFPB ranked by overdraft and NSF income, 19 of those 20 have stopped charging NSF (returned item) fees, which are distinctly different than overdraft fees because they are charged when an institution doesn’t cover an item – the opposite of what happens with overdraft fees where the consumer receives a substantial benefit from having a transaction paid at the institution’s risk.
Many institutions also have added grace periods during which no overdraft fees will be charged, caps on the number or dollar amount of fees charged in a day, policies providing that if the account is overdrawn by less than a de minimis (“cushion”) amount then no overdraft fees will be charged that day, and other consumer-friendly changes.
For our part, Velocity introduced fees-to-deposits functionality that allows financial institutions to automatically taper overdraft usage when overdraft fees represent an unreasonable percentage of a consumer’s deposits. We also bring ability-to-repay functionality to institutions which would not be able to develop this internally. This kind of underwriting has been viewed as important by the OCC in a bulletin it published in 2023, recommending periodic “account analyses that result in appropriate changes to overdraft limits.”
Also, the number of small-dollar short-terms loans our clients have made through our platform using the same underwriting has grown by 10x over the past three years – growth demonstrating that overdraft alternatives provided by banks and credit unions are real and are working.
And while our focus is on overdraft and not NSF, we also help institutions identify re-presented items which generate multiple NSF fees so they can proactively refund those fees to consumers.
All of these are responsible, sensible changes focused on improving fairness. The CFPB’s best move would be to continue working collaboratively with industry instead of proposing a rule that ignores the Fed study’s “findings [which] suggest that overdraft fee caps cause rationing of overdraft credit and inhibit financial inclusion, revealing a policy trade-off not previously considered: the benefits of a fee limit come at the cost of more unbanked, low-income households”, which would unequivocally harm consumers.
Surely this is not the result the Bureau wants, and the banking industry does not want this result either. Collaboration with industry to continue to encourage a greater focus on fairness instead of a problematic proposed rule would be a better result for everyone.
* Number of total complaints to CFPB in 2023 was 1,290,368; number of complaints in 2023 for overdraft and overdraft fees was 1,878; this represents 0.1455% of all complaints in 2023. If you include NSF fees in addition to overdraft and overdraft fees, the total was 2,611, which represents 0.2023% of all complaints in 2023.
About Christopher Leonard
Article written by Velocity Solutions CEO, Christopher Leonard, one of the industry’s foremost experts on overdraft regulation. Christopher regularly consults with our clients to help them develop the fairest, most responsible approach to providing consumer liquidity options.
Questions? Email Christopher — he really will read it and respond! AsktheCEO@myvelocity.com