Credit Unions Should Rethink Their Overreliance on Overdraft & NSF Fees

Remember Blockbuster Video? It was once ubiquitous: More than 9,000 locations, nearly $6 billion in yearly revenue, and lots of late fees. Altogether, those late fees added up to $800 million annually during the company’s peak in the early 2000s.

Although customers hated those late fees, Blockbuster became overly reliant on that income. When Netflix’s online ordering, mail-in return, low monthly fee and no-late-fees model came along, Blockbuster was then too slow to adjust. And, well, you know the rest of the story: Blockbuster withered until it went bankrupt.

The lesson from Blockbuster’s downfall is this: Profiting from consumers’ problems can come back and bite you. That’s because, at some point, your competition will solve your customer’s problems. It’s happening right now in financial services.

In fact, the CFPB found that roughly two out of three banks with $10 billion or more in assets have eliminated non-sufficient fund fees, saving consumers nearly $2 billion annually. But, among credit unions with greater than $10 billion in assets, 16 of 20 continue to charge NSF fees, including four of the five largest.

What’s more, a recent regulatory report found that 114 state-chartered credit unions in California collected approximately $252 million in overdraft and NSF fees in 2022 alone. In some instances, those fees constituted a large proportion of total revenue.

With markets changing, it’s time for credit unions of all sizes and charter types to reevaluate their overdraft and NSF fee programs. These programs can harm consumers, and they’re also unsustainable in the long run. That’s because the failure to adjust to market changes and diversify income streams can eventually lead to safety-and-soundness problems.

An overreliance on overdraft and NSF fees adversely affects both members and their credit unions. Institutions that rely more on fee income have greater concentration risk. And, in far too many instances, the most vulnerable members – people of color and those with lower incomes – are the ones paying the bulk of these fees. That’s inequitable.

Overdraft and NSF programs can serve legitimate purposes by inducing sound account management and providing a liquidity buffer when consumers unintentionally overdraw their accounts. And, many credit unions offer these programs responsibly or provide other less costly options. But, counter to the statutory mission of meeting the credit and savings needs of their members – especially those of modest means – too many credit unions still rely on this fee income as a significant revenue source.

For its part, the NCUA has sharpened its focus on the prudential and consumer financial protection issues posed by overdraft programs. In 2022, examiners requested information about a credit union’s overdraft policies and procedures. In 2023, NCUA examiners started conducting reviews of overdraft website advertising, balance calculation methods and settlement processes for federal credit unions with assets totaling $500 million or more. This year, examiners will perform these same reviews at federal credit unions with assets above $100 million.

Transparency matters, too. Credit union member-owners and the public have a right to know how much income a credit union generates from overdraft and NSF fees. That’s why the NCUA – beginning with the 2024 first quarter Call Report – will require federally insured credit unions with more than $1 billion in assets to disclose, separately, income from overdraft and NSF fees. That change will also allow credit unions to better benchmark their overdraft programs against other financial institutions.

A well-structured, diversified balance sheet includes an assortment of revenue sources. To enhance revenue streams, credit unions can build their member base and make prudent adjustments to investment portfolios. They can also originate a greater number of safe, fair and affordable mortgages. And, they can underwrite new loans by using alternative ways to identify the creditworthiness of their members.

Credit unions also have ways to adjust their overdraft programs to better protect members. They can add features like linking to savings accounts; create affordable new lines of low-dollar, short-term credit within the current interest-rate ceiling; use the NCUA’s Payday Alternative Loans rule to bridge household budget gaps; and help members increase emergency savings.

The hard truth is that as more banks decrease overdraft fees or drop them altogether, consumers will expect their credit unions to follow. Those credit unions that fail to recognize the evolving market and regulatory landscape, their not-for-profit mission and their members’ well-being will find themselves behind the curve.

Credit unions that fail to adjust may even end up in the dustbin of history. Just ask Blockbuster Video.