Competition Drives Overdraft Overhaul

The evolution of overdraft is upon us, but it isn’t regulators who are leading the charge. Instead, it’s good old-fashioned competition.

That is one of the conclusions of new Curinos research that examines the role of overdraft amid a wave of new policies and programs among financial-services providers. The research — which confirms and expands upon previous work from Curinos, regulators and consumer advocates, also finds that consumers have a deep understanding of overdraft and the fees associated with it.

There is also a clear message for banks: consumers view providers that innovate overdraft policies and offer overdraft alternatives as being distinctive – and they are more likely to bank with them.

THE RESEARCH

This article summarizes key findings of a comprehensive overdraft study that Curinos released last month. The research also builds upon a study that Curinos conducted in 2015 to understand why consumers use overdraft and choose to opt in to debit overdraft coverage.

Curinos commissioned an online survey of 2,251 consumers in April 2021, focused on consumer overdraft behavior and the reasons and decision-making process behind this behavior. The online survey sought sufficient responses from eight identified segments of consumers, defined by their frequency of overdraft in the past year (none, 1-5, 6-10, more than 10) and by their self-stated credit quality (could or couldn’t qualify for a credit card).

The survey aimed to provide an update to our research from 2015 to understand what, if anything, has changed about consumer behavior and attitudes in the intervening years. As such, many of the questions asked in the 2015 research were asked verbatim in this research to ensure a consistent comparison between the time periods.

This study was initiated at the request of the Consumer Bankers Association to better understand consumer sentiment and fill a gap in current research. CBA provided funding for the market research survey. Curinos independently designed, analyzed and documented research results.

KEY FINDINGS

• Overdraft fee revenue is down significantly. U.S. overdraft revenue fell approximately 57% from $40 billion in 2008 to $17 billion in 2019. (See Figure 1.)
• Fewer people use overdraft. The percentage of regular overdraft users (those with 10 or more transactions annually) fell by 40% to 4.9% of the population between 2010 and 2020.
• Challengers that adopt consumer-friendly policies win market share. New entrants, including fintechs and challenger banks, have created solutions to better manage or reduce the cost of overdraft.
• These entities have experienced a 40% improvement in account acquisition since 2017. Financial institutions that haven’t adopted overdraft innovation have experienced a nearly 30% reduction in consumer acquisition. (See Figure 2.)

Figure 1: Overdraft Fees, Total and Per Capita

Figure 2: Innovation and Account Acquisition

• Consumers understand overdraft. Consumers, especially overdraft users, continue to demonstrate a deep understanding of overdraft and available alternatives. More than 60% of overdrafts come from consumers who intend to use the service. More than 80% of overdraft transactions come from consumers who opted in to debit card overdraft programs with the clear intention of using it to cover their payments. (See Figure 3.)
• Two-thirds of consumers indicate that, while overdraft can be expensive, they don’t want to see reductions in their access to the service.
• Consumers want more short-term liquidity choices. Consumers seek convenient and relevant alternatives to overdraft. The emergence of alternatives in the market is driving consideration of new checking purchases.
• Larger transactions now trigger overdraft. The proliferation of overdraft grace balances and changes in posting order practices have reduced the number of small purchases that are tied to overdraft. As a result, the average size of purchases that trigger overdraft fees has nearly quadrupled from $50 to almost $200.

Figure 3: What was your primary reason for opting in?

Innovation Wins The DaY

Overdraft innovation has become the centerpiece of many new entrants that are challenging traditional banks. Their efforts have also prompted many of the traditional players to evolve their offerings.

Indeed, Curinos believes that new technology and a focus on the importance of financial health have driven more innovation than have regulatory actions. From Safe Money accounts that were introduced 20 years ago to the recent flurry of announcements from traditional providers who are dropping overdraft fees altogether, these market-driven innovations have a positive impact on consumer consideration and purchase.

Furthermore, they provide competitive advantages to the financial institutions that adopt them. When asked if they would consider an online-only or network bank for transaction services if they offered these consumer-friendly overdraft and overdraft alternatives, they clearly no longer hold a preference for traditional bricks-and-mortar banks and instead would consider banks based on the features they offered. (See Figure 4.)

Figure 3: Average likelihood to switch banks for an overdraft feature (%)

Where to Go From Here

Given the wave of change that has enveloped the industry in the last few months alone, all financial institutions should be reviewing current overdraft policies and pricing to ensure they remain competitive. They should also consider ways to potentially differentiate themselves from others.

There is little doubt that a growing number of institutions will offer innovative liquidity and overdraft solutions while improving traditional overdraft fee structures and policies. Indeed, those efforts have already begun, but they bring their own set of challenges. (See sidebar.)

Banks can use more advanced metrics and analytics to help create new products and manage consumer health and performance. This includes comparing unique customer cohorts to identify products that fit their needs and educate them about their financial lives.

It is increasingly clear that consumers want and need these new alternatives. The burden is now on banks to provide them – or risk losing this important set of customers.

Deposit Analytics Add New Lens to Credit Underwriting

Deposit-holding lenders are uniquely positioned to expand access to credit, driving financial inclusion while deepening customer relationships.

Lenders are increasingly looking for alternative data sources to improve credit decisions across the credit spectrum. This is particularly important to drive financial inclusion for thin-file or no-file customers.

Curinos’ research and client experience has shown that on-us deposit behaviors are highly predictive of credit performance. By leveraging customer deposit behaviors to better understand a customer’s ability and willingness to repay, lenders can approve as many as 10%-40% of applications that historically would have been rejected.

Traditional credit underwriting has left many behind, limiting a large segment of the population to costly forms of credit such as payday loans. According to the Office of the Comptroller of the Currency (OCC), “Nearly 50 million people in the United States have no usable credit scores.” Building credit is critical to unlocking financial opportunities, such as wealth building through home ownership.

Regulators have recognized this problem and are starting to look at the structural barriers to financial inclusion. Industry providers have also taken action – some are expanding traditional payment data by analyzing phone, utility and streaming bills. This, however, ultimately represents just another flavor of assessing prior behavior within the credit landscape.

Lenders who hold deposits are in a unique position to expand financial inclusion with their deposit customers. They have extensive data on their customer’s deposit accounts, which provide a comprehensive view of applicants’ financial well-being. This data is FCRA compliant and already sits within the lender’s firewall.

And while many fintech lenders are using self-permissioned deposit data to improve underwriting, adverse selection may be an issue. Customers worried about being approved may be the only ones to provide deposit data and, when provided, may only choose to share accounts that paint their best financial picture.

Deposit-holding lenders, on the other hand, have unbiased and consistent historical deposit data that can be used for modeling. Fortunately for them, as much as 90% of consumer loans are underwritten to existing deposit customers. This also presents a chance to deepen customer relationships by saying “yes” when other lenders using traditional credit data would have to say “no.”

For those institutions that are fortunate enough to have historical deposit data, the right metrics are critical. For example, a simple metric like total balances does a great job discriminating overall risk – those with more than $6,000 in balances are eight times less risky than those without. But, that simple metric won’t materially help approve more customers, as those with more than $6,000 are already much more likely to be approved (for one lender, approved customers had $40,000 in average deposits, while rejected customers had only $5,000). To approve more customers without increasing risk, lenders must use advanced deposit metrics to understand the behaviors that drive deposit balance changes.

Ultimately, on-us deposit data are a rich source of alternative credit data that are proprietary to each deposit-holding lender. Curinos has found that lenders can approve up to 40% of historically rejected applications without increasing risk by leveraging advanced deposit behavioral metrics, expanding financial inclusion while simultaneously deepening customer relationships.