How $36.50 Bottles of Water Are Helping Banks Through the Recession

Banks need a break, right? After all the bailouts, I thought so, too. Until this morning.

As it turns out, banks may be eating some bad loans, but they’re raking in cash from other sources. The Financial Times reported that banks will charge customers more than $38.5 billion in overdraft fees this year, a record. Many banks have increased their overdraft fees during the past year. It’s the first time in more than 40 years that banks raised fees in a recession.

The following table shows the amount of total fees on deposit accounts for the first quarter of 2009.

Institution Fees
Bank of America (NYSE: BAC) $2.6 billion
J.P. Morgan Chase (NYSE: JPM) $1.4 billion
Wells Fargo (NYSE: WFC) $763 million
US Bank (NYSE: USB) $363 million
SunTrust (NYSE: STI) $206.6 million
Regions Financial (NYSE: RF) $197 million
Citigroup (NYSE: C) $166 million

Many of the banks charging these fees received taxpayer-funded bailouts. After President Obama’s Credit Card Accountability Responsibility and Disclosure Act made it difficult for banks to raise interest rates on late-paying consumers, banks have begun relying more heavily on fee income. Overdraft charges have the potential to net the most profit. They already make up more than 75% of the service fees consumers pay.

Out of the 2,000 banks surveyed, 44.5% had more in fee income than they had in overall net income. The most cash-strapped customers are hit the hardest, with 90% of overdraft revenue coming from only 10% of the 130 million U.S. checking accounts, ostensibly the 10% with the lowest balances. The survey also found that the people who overdraft their account on a regular basis tend to have low credit scores, which makes them ineligible for other sources of credit.

How Banks Use These “Mini-Loans” to Take Advantage of Customers
Banks provide this “overdraft protection” as a service to help customers avoid bouncing checks or having their debit cards declined. If a customer doesn’t have the funds in his or her account, the bank will make a mini-loan with the expectation that you’ll pay it back within a few days.

I use Bank of America, and have had (too much) personal experience with its overdraft protection. If I stop for a bottle of water but don’t have enough money in my checking account, BofA doesn’t decline the transaction. It will cover the $1.50 bottle of water and charge me $35 as a convenience fee (for a total of $36.50!). That’s an expensive bottle of water!

If I don’t realize my balance is low and continue spending money, I’ll be charged the $35 fee for each purchase I make, up to 10 times in a single day. That an extra $350 I’ll have to pay in addition to the total of the 10 purchases. And if I don’t cover the overdrafts, I’m subject to even more charges. By the time I realize anything’s amiss, I’d be out more than $400. It’s makes me feel broke just thinking about it.

But my account isn’t alone. According to the report, 35% of all financial institutions allow consumers to overdraw their accounts at ATMs or with a debit card. They charge an average $26 for the service. The large national banks, BofA, J.P. Morgan Chase, Citigroup and Wells Fargo, all charge more than $30 for each fee.

Here’s the kicker: While most banks process a customer’s debits in the order they’re made, one bank out of five rearranges them from largest to smallest. This increases the chance of a consumer overdrawing on a big charge ($26 here) and then further overdrawing on several smaller charges (another $26 there, there and there).

Banks, for their part, say the fees are fair to compensate for the risk they take when they cover customers’ charges. “It’s a service to our customers. They want us to pay their overdrafts,” one senior banker told the Financial Times.

The Most Important Thing to Know When It Comes to Overdraft Charges
Consumer advocacy groups say overdraft fees are abusive behavior that’s directed at the most vulnerable. Overdrafts, they say, are the least risky form of credit, which should make it the cheapest. But it’s the most expensive.

Lawmakers and regulators are listening. The Federal Reserve is working on creating standard rules regarding overdraft fees, including one that would make it mandatory for all banks to give customers the option to have their card declined instead of paying the fee. Rules on consumer charges could become a priority of Obama’s proposed Consumer Protection Agency, if that agency’s creation is approved by Congress.

Until then, there’s another statistic you should be interested in: Of the banks that offer overdraft protection, 86% allow the consumer to opt-out at anytime. If you don’t want to pay the fee, you don’t have to: The bank will simply return the check or decline the debit card purchase if your balance doesn’t cover the purchase.

Of course, this whole brouhaha would be avoidable if consumers were simply more aware of their account balances. Many banks also offer free access to online banking, where you can see your current balance. Other services, many of them free, also can help. Bank of America sends me an e-mail every morning with an update on my balance. Another person in our office gets an automated call if his balance slips below a certain level. Neither service costs a dime.