Check bounce programs, cash sweep programs and payment lines of credit—each brings a different set of regulatory requirements, policies, procedures and practices.

In addition to federal laws and regulations, the federal bank regulatory agencies have issued two policy documents that remain the principal sources of guidance on their expectations for overdraft programs. In February 2005, the Federal Reserve released guidance on overdraft protection programs, Joint Guidance on Overdraft Protection Programs. In November 2010, following an extensive study of overdraft payment programs, the FDIC published FIL-81-2010 Overdraft Payment Programs and Consumer Protection Final Overdraft Payment Supervisory Guidance

Then, most recently, in February 2012 the Consumer Financial Protection Bureau launched an inquiry into checking account overdraft programs to determine how industry practices affect consumers. The comment period for the inquiry closed in June 2012. The bureau’s findings have not yet been published; however, it is expected that additional guidance will result.

Overdraft program options

Community banks generally use three types of arrangements to cover account overdrafts. The first is a true line of credit that requires credit approval, and an agreement exists for the bank to transfer an overdraft balance to the credit line. The credit line is subject to the Truth in Lending Act, and the terms and conditions are agreed upon in advance by both parties.

The next type of overdraft program is what is usually called a sweep-account arrangement. In this case, the bank agrees with the account holder to “sweep” funds from another account owned by the customer, typically involving funds on deposit in an interest-bearing account. This arrangement does not create a loan because the funds used to cover the overdraft are already on deposit at the bank.

The third type of overdraft coverage community banks offer is an overdraft protection program, also called an ad hoc program, or “bounce protection” program. For this type of account, banks typically disclose the availability of the bounce protection program in the disclosures presented at account opening. If the accountholder doesn’t execute an opt-out provision, the protection becomes effective when the account meets the program’s guidelines, such as the account’s balance or the number or amount of deposits made. For bounce protection, the bank usually makes a decision on paying items as they are presented.

Although each overdraft creates a “loan” from the bank to the account holder, these programs are not covered by a loan agreement, and financial institutions reserve the right to pay or not pay an item. Bounce programs are not subject to Regulation Z. A non-sufficient funds fee may apply for each item presented. That fee would generally be charged whether the item was paid or returned. Many banks contact the account holder and require that the item be covered within a specified timeframe. These programs are convenient for account holders and generate valuable and legitimate service fee income for banks.

Lastly, although not common for community banks, some institutions use an automated overdraft payment program. A sort of check bounce-protection program, this program runs on predetermined criteria without involving bank employees. Automated overdraft payment programs are the focus of the FDIC’s 2010 guidance, which emphasizes that the FDIC expects the institutions it supervises to implement effective compliance and risk management systems for automated overdraft payment programs.

An automated overdraft payment program is a variation of a bounce program and typically includes the following characteristics:

• is partially or fully computerized;
• is used by an institution to determine whether non-sufficient funds transactions qualify for overdraft coverage based on predetermined criteria; and
• the decision to pay or return specific items is determined by pre-established criteria and generally does not rely on bank employee decision-making with respect to any individual customer or item.

Rules and best practices

Banks not directly supervised by the FDIC should still look to the 2010 guidance as industry “best practices.” Some recommendations from the guidance are:

• provide clear and meaningful disclosures;
• give consumers the opportunity to affirmatively choose the overdraft payment product that best meets their needs;
• implement appropriate daily limits on overdraft fees; and
• do not process transactions in a manner designed to maximize the cost to consumers.

Let’s take a look at these four types of consumer account overdraft programs—overdraft lines of credit, sweep programs, bound programs and automated overdraft programs—and a short summary of the regulatory requirements that apply to each.

Overdraft lines of credit

• Regulation Z (Truth in Lending Act) requires open-ended disclosures for opening these accounts. Regulation also requires banks to provide periodic statements; transaction descriptions; subsequent disclosures, payments and treatment of credit balances; and billing-error resolutions. Rule carries APR calculation and advertising disclosure requirements.
• Regulation B (Equal Credit Opportunity Act) applies to any credit-related application or extension.
• Regulation DD (Truth in Savings Act) applies to any fee that is imposed in connection with an account, including the conditions under which the fee will be charged. Although overdraft fees are disclosed with line-of-credit disclosures under Regulation Z, Truth in Savings Act disclosures would also apply to charging fees for nonsufficient funds/overdraft activity on deposit accounts.
• Regulation E (Electronic Fund Transfers Act) disclosures and opt-in requirements for paying ATM and one-time point-of-sale overdrafts provided in exchange for a fee do not apply.
• Third-party arrangements that administer overdraft payment programs should conform to general vendor-management principles. Vendor compensation and potential UDAAP violations are particular areas of risk.
• Unfair, Deceptive or Abusive Acts or Practices (UDAAP) regulatory interpretations are broad and have the potential to apply to all activities, all bank employees and certain third parties.
• Regulation CC (Expedited Funds Availability Act) applies to two elements of overdraft programs. First, the rule applies when a bank extends the time when funds will be available for withdrawal because it doubts collectability. Under certain circumstances, the bank is prohibited from assessing any fees for subsequent overdrafts—including those from a line of credit—or for return of checks or other debits to the account. Second, the rule applies for holds on checks deposited into accounts that have been repeatedly overdrawn. (See Reg CC Section 229.13(e) for specific requirements.)

Sweep overdraft program

• Regulation Z (Truth in Lending Act) does not apply.
• Regulation B (Equal Credit Opportunity Act) does not specifically apply, but overdraft programs should comply with general standards outlined in agency guidance. Overdraft program criteria should avoid arrangements that could be considered inadvertent discriminatory practices, such as “steering” customers on a prohibited basis toward overdraft coverage while offering other classes of customers less costly overdraft processing options, such as a line of credit.
• Regulation DD (Truth in Savings Act) requires disclosures for any fee imposed in connection with an account, including the conditions under which a fee will be charged. Fees must be included in account disclosures. Disclosures must outline transaction limitations for transfers of funds out of savings deposits by preauthorized agreement.
• Regulation E (Electronic Fund Transfers Act) does not apply.
• Third-party arrangements that administer overdraft payment programs should conform to general vendor-management principles. Vendor compensation and potential UDAAP violations are particular areas of risk.
• Unfair, Deceptive or Abusive Acts or Practices (UDAAP) regulatory interpretations are broad and have the potential to apply to all activities, all bank employees and certain third parties.
• Regulation CC (Expedited Funds Availability Act) applies to two elements of overdraft programs. First, the rule applies when a bank extends the time when funds will be available for withdrawal because it doubts collectability. Under certain circumstances, the bank is prohibited from assessing any fees for subsequent overdrafts, including those from a line of credit, or for return of checks or other debits to the account. Second, the rule applies for holds on checks deposited into accounts that have been repeatedly overdrawn. (See Reg CC Section 229.13(e) for specific requirements.)

Bounce programs

• Regulation Z (Truth in Lending Act) does not apply. Ad hoc bounce programs do not require an upfront credit agreement with the account holder.
• Regulation B (Equal Credit Opportunity Act) does not specifically apply, but overdraft programs should comply with general standards outlined in agency guidance. Overdraft program criteria should avoid arrangements that could be considered inadvertent discriminatory practices, such as “steering” customers on a prohibited basis toward overdraft coverage while offering other classes of customers less costly overdraft processing options, such as a line of credit.
• Regulation DD (Truth in Savings Act) requires disclosures for any fee imposed in connection with an account, including the conditions under which a fee will be charged. Fees must be included in account disclosures.
• Regulation E (Electronic Fund Transfers Act) requires that customers receive a notice and a reasonable opportunity to opt-in to payments of ATM, one-time and point-of-sale overdrafts provided in exchange for a fee.
• Third-party arrangements that administer overdraft payment programs should conform to general vendor-management principles. Vendor compensation and potential UDAAP violations are particular areas of risk.
• Unfair, Deceptive or Abusive Acts or Practices (UDAAP) regulatory interpretations are broad and have the potential to apply to all activities, all bank employees and certain third parties.
• Regulation CC (Expedited Funds Availability Act) applies to two elements of overdraft programs. First, the rule applies when a bank extends the time when funds will be available for withdrawal because it doubts collectability. Under certain circumstances, the bank is prohibited from assessing any fees for subsequent overdrafts, including those from a line of credit, or for return of checks or other debits to the account. Second, the rule applies for holds on checks deposited into accounts that have been repeatedly overdrawn. (See Reg CC Section 229.13(e) for specific requirements.)

Automated overdraft program

• Regulation Z (Truth in Lending Act) does not apply. As variation of a bound program, an automated overdraft program does not require an upfront credit agreement executed with the accountholder or a Reg Z disclosure.
• Regulation B (Equal Credit Opportunity Act) does not specifically apply, but overdraft programs should comply with general standards outlined in agency guidance. Overdraft program criteria should avoid arrangements that could be considered inadvertent discriminatory practices, such as “steering” customers on a prohibited basis toward overdraft coverage while offering other classes of customers less costly overdraft processing options, such as a line of credit.
• Regulation DD (Truth in Savings Act) requires disclosures for any fee imposed in connection with an account, including the conditions under which a fee will be charged.
• Regulation E (Electronic Fund Transfers Act) requires that customers receive a notice and a reasonable opportunity to opt-in to payments of ATM, one-time and point-of-sale overdrafts provided in exchange for a fee.
• Third-party arrangements that administer overdraft payment programs should conform to general vendor-management principles. Vendor compensation and potential UDAAP violations are particular areas of risk.
• Unfair, Deceptive or Abusive Acts or Practices (UDAAP) regulatory interpretations are broad and have the potential to apply to all activities, all bank employees and certain third parties.
• Regulation CC (Expedited Funds Availability Act) applies to two elements of overdraft programs. First, the rule applies when a bank extends the time when funds will be available for withdrawal because it collectability. Under certain circumstances, the bank is prohibited from assessing any fees for subsequent overdrafts, including those from a line of credit, or for return of checks or other debits to the account. Second, the rule applies for holds on checks deposited into accounts that have been repeatedly overdrawn. (See Reg CC Section 229.13(e) for specific requirements.)

Your community bank’s management should ensure that all of its overdraft payment and line-of-credit practices conform to all applicable laws and regulations. Following the agencies’ guidance and building appropriate regulatory checks into your bank’s compliance program will mitigate safety and compliance risks, and reduce the possibility of violations.

Mary Thorson  is vice president of Chartwell Compliance, an ICBA Compliance & Risk Management service provider.