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Overdraft fee reform debate begins now

Congress took a major step toward restricting the way banks charge overdraft fees this week with the introduction of legislation in both the House and Senate.

It was an active week for Congress and banking legislation: on Thursday, a House committee also approved a bill to create a Consumer Financial Safety Commission, and passed another measure designed to speed up enactment of new consumer protections for credit card users.

But overdraft fees are a particular sore spot with consumers, who will pay $27 billion to banks for overdrafts this year, according to research firm Moebs Services Inc.  The Center for Responsible Lending says one in six U.S. consumers were hit by overdraft fees last year.

Earlier this week, Sen. Chris Dodd, D-Conn., introduced the Fairness and Accountability in Receiving Overdraft Coverage Act, or "FAIR Act",  which would require financial institutions to obtain explicit permission from all their customers before enrolling them in a system of fee-based overdraft protection for debit card and ATM transactions.

On Thursday, Rep. Carolyn Maloney, D-N.Y., who has proposed overdraft legislation for several years, introduced a new version of her bill to match Dodd's proposal.  The updated bill is co-sponsored by Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.

The House version could be debated as early as next week, and aides said they hope the legislation could be sent to the White House before the end of the year.

This latest overdraft legislation would add a series of new consumer protections related to overdraft fees. Both bills would:

*Require new systems to warn consumers who are about to make a withdrawal at an ATM that would lead to an overdraft, and give consumers a chance to back out of the transaction.

*Mandate that overdraft fees be "reasonable" and "bear some relationship to the cost of covering the overdraft."

*Prohibit reordering of customer transactions to trigger otherwise avoidable overdraft fees -- sometimes known as high-low check processing -- a particularly irksome practice for consumers whose checking account balances hover near zero.

*Limit the number of overdraft fees per person to six each year, and no more than one per month.  At that point, financial institutions would have to enroll the consumer in a lower-cost program or stop charging for covering overdrafts.

Earlier versions of Maloney's bill would have required additional warnings for consumers at point-of-sale terminals in retail stores, where shoppers can incur overdrafts when using their debit cards for purchases.  Many store terminals don't currently have the ability to perform such calculations, however, so that provision was dropped and replaced with a mandate that the Government Accountability Office study the issue.

Already, some financial institutions have begun to voluntarily adopt some of the provisions in the overdraft legislation. Earlier this month, Bank of America said it would give account holders the choice to opt out of automated overdraft protection, and it announced plans to limit the number of overdraft fees each customer can be charged annually. JP Morgan Chase said it plans to discontinue high-low check processing. But Maloney said those steps didn't go far enough to stem the need for a new law.

"To be sure, some financial institutions have begun to take some steps to dial back the burden their overdraft policies have placed on consumers," she said. "But those steps have been small, and customers of all banks must be protected equally."

Consumer groups lauded the move.

"We are pleased that this bill would put long-overdue brakes on abusive overdraft practices by banks and credit unions, practices that make holding on to and managing the money in their checking accounts difficult for many Americans." said a coalition of consumer organizations, including Consumers Union and the Center for Responsible Lending.

The end of free checking?

Despite the voluntary steps banks have taken to curtail some overdraft practices, the industry is loathe to surrender what for some banks has become an essential revenue stream. The American Bankers Association released a survey earlier this year saying consumers prefer automatic overdraft protection.

ABA Senior Vice President and Kenneth J. Clayton said consumer would miss the account feature if legislation prevented banks made it infeasible for banks enrolling consumers during Congressional testimony on an earlier version of overdraft legislation.

"Consumers value banks' practice  of paying overdrafts," Clayton said.  "While this service may cost the customer money, as there are fees associated with its availability, in many cases it would cost the customer more to endure the inconvenience, embarrassment and fees charged by the merchant or payment recipient were the payment to be declined. It is important to remember that this cost is completely avoidable and consumers can take numerous steps to keep track of their balances and manage the risks associated with over-drafting their accounts."

Meanwhile, Michael Moebs, a banking industry advisor, told the New York Times last week that 1,000 to 2,000 banks and credit unions would fail if the overdraft legislation is approved.  Nearly half of all banks collect more in overdraft fees than they earn in profits, he said.

When Congress debated the new credit card consumer protection legislation earlier this year, bankers predicted the new law would lead to unpleasant consequences: higher interest rates, lower credit limits and other painful cost-saving measures by card issuers. Those predictions have come true, though some debate the direct cause-and-effect claims by the industry.

Similar dire predictions surround the overdraft law.  Many predict an end to free checking accounts, for example. Maloney said such warning should not deter Congress.

"Right now we have unpleasant consequences," she said. "We want charges and fees to be up-front and transparent to the consumer. We don't know if they'll start charging for checking accounts. What we do know is that overdraft programs as currently implemented are more like scams perpetrated on unknowing consumers, and they don't allow consumers to make their own decisions and allow the market to work."