I'm sure someone has received a FRB opinion on this one - but Reg. DD commentary wasn't updated. A few months ago our bank was approached by a marketing firm about increasing fee income - overdraft fee income specifically - provided we offer a FREE checking accounts.

Q: If overdraft fees are charged, can banks advertise checking accounts as "free"? I've reviewed Reg. DD Commentary 230.8(a)#3&4.
Under 4(iv) NSF charges are specifically exempted (checks RETURNED UNPAID). However, overdraft fees are NOT specifically addressed.
I'm thinking about the following approach - but need your thoughts if this will stand up to examiner review. Per 3(ii), I believe the TYPICAL customer does NOT REASONABLY expect to incur OVERDRAFT fees on a REGULAR basis. Thus OD fees would NOT fall within any of the requirements under #3.
The only questionable part of this thought process is that the whole reason for offering "free" checking is to attract customers who are currently not banking customers and use "payday loan advance" type services. Increases in OD fee income is suppose to cover any lost monthly maintenance fee income and OD charge-offs. So, under this situation, where we are to anticipate that customers will regularly have OD fees, can we still call this checking account Free?

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Any opinion stated above is mine alone and not my employer's.

Your logic is right on. Although OD fees are not specifically mentionned, they are included in the term "NSF fee". Most banks charge an NSF and OD fee on free checking acounts.

[This message has been edited by David Dickinson (edited 05-14-2001).]

As a caution, be sure to check your state law about overdraft fees before proceeding. These fees may be considered a finance charge on an unsecured credit extension and be far in excess of usury limits.

Soapbox commentary follows:

The more banks try to go this approach to compete with payday lenders and such, the more likely it will be that we will soon see legislation and regulation about what amount of fees we can charge and how we must disclose these fees. Already some states treat overdraft fees that are assessed on a regular basis for the period of time the account is in the red as a finance charge on an unsecured loan. And in reality, that's exactly what it is. I know Reg Z currently exempts overdraft fees from being a finance charge. But let banks keep up this more common practice, and pretty soon look for that exemption to change. Think about the interpretation of what you have said about this program:

OK, we're going to offer a new product that many of our lower income customers will like - it's FREE checking! How can we do this and still be profitable? Well, here's how it will work. Some of these customers will maintain their accounts just fine, and they'll really like this product. Other of our customers won't do so well, and they will periodically overdraw their account. We're going to stick it to those guys to pay for the services of everyone. It'll be OK, because these guys are already paying high fees to the payday lenders and such, so they won't mind this very much either - we're actually saving them money!

Can anyone say Reg FF?

OK, I'm off the soapbox.

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Opinions expressed are my own, and do not necessarily reflect those of my employer.

We are also talking about offering a product such as this, but I am having trouble convincing myself that this is not open-end credit under Z. Is there a way to offer this product that would make it exempt from the open-end disclsoure requirements?

I'm not sure I follow you Peggy, but a checking account with an overdraft is NOT subject to Reg Z. It is not a loan but a deposit account. The deposit laws do not call an overdraft a loan.

David, doesn't it meet the definition of open-end credit under Reg. Z? Wouldn't it be considered an overdraft line of credit?

David & Peggy - read J. Bedsole's reply again. Reg. Z becomes a concern when you charge an OD fee based upon the number of days the OD is outstanding. A single OD fee per occurrence/item is not a Reg. Z FC fee. My concern -- my affiliate banks are charging an OD fee per item, as well as an overdraft duration fee - some are daily, others per every three days outstanding and others are per every 5 days outstanding. Does anyone know of a state law (any state) that has determined on a state level that duration OD fees are FCs subject to the state's usary laws?

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Any opinion stated above is mine alone and not my employer's.

[This message has been edited by D. Whitney (edited 06-06-2001).]

Sorry David, but while the checking account is a deposit account, the overdraft feature is credit and it is subject to Regulation Z if it meets Regulation Z's definition of credit. If you have an agreement to pay the overdraft, the agreement fulfills the definition of open end credit and all fees may be finance charges. Regulation Z doesn't care that the credit feature is attached to a deposit account.

Lucy,
I think there is a distinction between a checking account with an overdraft line of credit, and a checking account this is simply overdrawn (with no pre-approved agreement to overdraw the account.)

I think David was talking about the second situation. And yes, many banks are now going to the "per day" fee when a checking account is overdrawn and it does not have an Overdraft Line of credit tied to it.

In our case, we don't impose a fee unless the account is overdrawn $500 or more. Then the charge is $3 per day until the overdraft is cured. This way, the fee is not charged if someone inadvertently overdraws their account by a few $$ because they didn't account for the ATM fee or the monthly maintenance fee or they were a little off in their math.

With respect to how we would allow someone to be overdrawn $500 without Overdraft protection... Here's a scenario - you have a customer who has a solid history with the Bank, and perhaps a check they deposited bounced and now their car payment hits their account. In those cases, the Customer Service Manager may approve the overdraft because the customer will be replacing the deposit the next day.

The customer appreciates the fact that you didn't bounce their car payment (as their lender would probably charge them $25 for the returned check as well as possibly damage their credit record) and the $3 per day fee reminds people they shouldn't take too long to cure the overdraft.

There are several companies that work with banks to install overdraft privilege programs, usually tied to free checking. The advantage of using one of these companies is that they have carefully worded notices and disclosures that avoid the credit issue. For example, the programs are intentionally called overdraft privilege, not overdraft protection, and the customers are told the bank is not obligated to pay their checks if their account is overdrawn, but the bank will pay the checks as a courtesy if the customer has met certain conditions.

Our bank has been using such a program for about nine months with great success. We offer the program with all personal checking accounts. We do not charge an overdraft fee based on time on consumer accounts because of the concerns mentioned in other responses.

There seems to be 2 different comments going on in this string. Bonnie is correct Lucy. All I said in my post to Peggy is if a bank pays an overdraft, this is not a Reg Z issue. Of course, if a bank offers an overdraft LINE OF CREDIT, that it would be credit and subject to Reg. Z. Checking, free or not, is not credit - even if the bank pays an occasional overdraft and charges the customer a fee for this one time action. If the bank attaches a overdraft protection (credit), the credit plan is subject to the Reg. Z requirements.

Not exactly. Regulation Z doesn't care what you call the account or what you call the bounced check privilege. It looks only at whether the bank is allowing the customer to incur debt and defer payment. This is clearly the case with any payment of an overdraft, whether pursuant to an agreement or not.

However, for Z purposes, you then have to look at whether there is an agreement that triggers disclosures. There can be credit, such as the single payment of a one-time overdraft -- which do not trigger any Z activity. Clearly, an agreement to pay overdrafts -- even if limited in amount -- is an open end credit agreement and would be subject to the O/E rules.

The really tricky question arises when you don't have a written agreement, but you establish with the practice of paying overdrafts and charging fees. That puts the bank into murky territory.

Okay, I agree with your thoughts Lucy, but the original question - to which I am trying to respond - is whether a free checking account is governed by Reg Z. The question was - Can a bank call an account free if it occasionally pays an overdraft? Just because I occasionally pay an overdraft doesn't mean I always have to. Without an overdraft protection plan, the banker decides on a case-by-case basis whether to treat it as a NSF or an OD. This is NOT subject to Reg. Z.

Correct. Reg Z doesn't care about checking accounts unless the overdraft activity becomes a question. The question as to whether or not the account is "free" is a DD question.

As I read 230.8, an overdraft fee is more like the types of fees that do not jeopardize the "free" status of an account. The fees that count are fees that are imposed if the account is used as the UCC and the contract provides (and contracts and UCC assume that the customer won't bounce checks.)

Maintenance and low balance fees would prevent the use of "free" to describe the account, but I would think that an overdraft fee would not make the account "un-free."

After reading this, I have to wonder about our program. We are offering free checking, BUT it does have an overdraft feature attached to it. Each customer is granted a $300 overdraft courtesy on which we will automaticaly pay all items up to $300 on the account, we reserve the right to pay these at our discretion. Even if they have $200 remaining, we don't have to pay the item. If the customer can show proof of direct deposit we will increase their overdraft courtesy to $500.

A fee of $22.00 is charged when an item is paid that makes them overdrawn but not on a daily basis.

I am thinking, based on what I have read in the postings so far, that we would be okay.?

You have no obligation to pay items, as I read your description, and you are not offering a line of credit. Reg Z is not applicable.

You are OK.

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Andy Zavoina
Opinions stated are not necessarily that of my employer.

In reading all the comments,I agree with Andy.

We ofer the same product but key point is your state law on this avenue You may have bank holdings in different states that view this option differently and how you disclose this product could become a problem issue.