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Is Your Overdraft Program a Black Box?
(Part 1)

Posted March 14, 2018 - Charles Baker

Do you really understand how your overdraft management program calculates overdraft limits? It shouldn’t be a mystery.  Once data goes into your system, which then outputs an overdraft limit, you should be able to clearly explain what has happened in the system to your examiners.  Further, if you understand the specific factors, trends and overrides that determine the overdraft limit, you’ll be able to customize your overdraft program to provide superior service to your account holders.

Overdraft programs can benefit from the wealth of information you have, such as consumer metrics, overdraft habits and trends, and you should be able to easily access that data to make informed decisions regarding the management of your overdraft program. Unfortunately, many overdraft programs provide only pre-configured reports, and upcharge for special queries, restricting your knowledge and understanding of the overall program.  They also often have pre-configured settings used to determine overdraft limits which are not visible to the financial institution, making your overdraft program a black box.

Is your overdraft program a black box? Ask yourself the following questions:

Do you know how to turn data into actionable information?

  1. Are all of the factors used to determine the limit visible to you (along with their weighting)?
  2. Can you track each account’s fees to deposit ratio? If an account holder is paying 25-30% of his or her deposits in fees, it’s most likely not sustainable.
  3. How do deposit patterns (such as the dollar amounts of deposits and frequency of deposits) affect your risk?
  4. Does your overdraft program identify specific factors and behaviors to reduce chargeoff exposure to your institution?
  5. And most importantly, are you able to easily identify and mitigate risk with your current system? The best type of overdraft software evaluates every account, every day, for its risk. If the risk increases or decreases, the limit is adjusted accordingly.

Do you have the real-world data to defend your overdraft program to an examiner?

The method your overdraft program uses to determine overdraft limits and account performance should be defendable, transparent and objectively determined across your financial institution. You should easily see how every limit is determined for every account over time.  What is that account holder doing today vs. a month ago, or two months ago? Have there been fluctuations or changes in deposit habits?

Can your system identify when the risk profile of an account has changed?

The right overdraft program identifies and mitigates the risk to your institution while simultaneously protecting the financial health of your account holders.

An effective overdraft program should work exactly like a hospital heart monitor – indicating good health with steady, consistent activity. The risk flag is waved when there’s a fluctuation in that activity.  Overdraft management systems should have a finger on the “pulse” of every account, every day, monitoring all changes in activity and adjusting the limit accordingly to keep your risk levels low.

When the OCC proposed overdraft program guidance in 2011, it stated that “changes in customer usage should be regularly monitored to identify risks. Appropriate action should be taken to address any risks that are identified including excessive usage and nonperformance, such as … adjusting credit terms, fees, or limits….” While the guidance wasn’t finalized, it indicates regulators’ thinking on this issue. Are you monitoring your accounts now and taking appropriate action?

Are refunds for overdraft fees granted equally and objectively across your institution?

In my experience, typical financial institutions maintain a fairly subjective refund policy.  Decisions for overdraft fee refunds often reside at the branch level or even at the front line.  Many institutions that claim to have more structured, formalized policies still often leave decisions to the front line’s discretion.

Here’s a simple example illustrating the problem with this approach:

Branch A:  Based in a wealthy, affluent town
Branch B:  Based in a poor inner city

Without the right software, refunds are subject to discretion.  And if Branch A’s refunds are significantly higher than Branch B, expect your examiners to notice. A cursory review may lead an examiner to falsely conclude that your financial institution is treating these consumers differently, simply because of socio-economic status.

An effective overdraft program looks at all factors in determining refund amounts. It uses the same metrics and the same algorithm for every account, applying it to deposit behavior, overdraft behavior, and historic patterns. It’s entirely machine-driven, providing an objective, fair and equitable decision, removing all human subjectivity.

Can your overdraft program provide a debit decline opportunity analysis?  

Debit declines play a significant role in the service your institution provides, and the strategy you choose has enormous potential to impact your institution’s financial performance. The right software identifies actionable events on each account:  Is this account holder an overdrafter? Is this account holder experiencing debit declines?  Did this account holder fail to respond to Reg. E, opting out by default?

This is where your opportunity lies. Debit declines are a double hit for your institution.  Your customer or member is receiving poor service, and your institution is losing potential overdraft revenue.  Consumers may not understand why their debit card was declined, and a simple conversation explaining Reg. E may turn a negative event into a positive event.

As for the analysis element, the right overdraft program should clearly show you where debit declines are occurring and the magnitude at which they’re occurring. Reporting should indicate the total amount of transactions that were declined, and the corresponding interchange revenue you’ve lost with each one. The right overdraft software can automatically send a letter for opt-in, queue up a call or initiate a conversation.

Further, the right overdraft software will help you analyze the root cause of debit declines.  “We declined $2 million in transactions yesterday due to default opt-outs, and 80% of those came from Branch 9. So, what’s going on at Branch 9?”

Check back next month for Part 2 of “Is Your Overdraft Program a Black Box?”

Charles Baker

Charles Baker is Director of Client Service for Velocity Solutions. He brings with him over 18 years of executive level sales, client services, and operations experience, primarily in the Banking, Technology, and Consulting Services industries.