Digital banks have entered the ring with a new value proposition: no overdraft fees. As megabanks mulled this over, they took a similar stance by slashing fees altogether or significantly decreasing them in an attempt to take back market share and account holders. The industry shift can be attributed to increased competition from digital-first banks, as well as government influence in the wake of the pandemic. This evolution puts enormous pressure on regional and community financial institutions (FIs) that heavily relied on overdraft services as a revenue stream.
According to The Financial Brand, “the implications of this situation cut two ways: 1. slashing a major source of noninterest income, and 2. raising technology costs due to the necessary system changes.”
While FIs may not have the resources to build their own technology, they can achieve competitive differentiation by utilizing a digital banking platform. By leveraging a strategic partner, FIs can deploy innovative online experiences without the costs of developing an in-house solution. Technology partnerships solve half of the equation, leaving FIs wondering how to reshape overdraft services and noninterest income at their institution.
Why do consumers need overdraft services?
Across the nation, consumers feel the heavy burden of rising prices. With 64% of Americans living paycheck to paycheck, many families struggle to pay their bills and rely on their FI for financial support.
Overdraft fees were developed as a deterrent, so consumers were less tempted to overdraw their accounts; with hopes of making them more “responsible” with their money. However, overdraft fees are used by a wide variety of consumers – young professionals, those scraping by with each paycheck, those overspending, and those not saving enough. In a report from Curinos, they found that 60% of overdrafters intended to use the service, and over 80% opted in for debit card overdraft protection with the intent of covering overdrawn payments. This acknowledgment means they are fully aware of the fee but still rely on the service for additional funds.
If banks cut overdraft fees, this could cause a shift for account holders. “A study from the Federal Reserve backs this up. It found when banks cut out their fees or cap them, they ‘reduce overdraft coverage and deposit supply, causing more returned checks and a decline in account ownership among low-income households,’” (The Financial Brand, 2022).
To support consumers, FIs should provide education and financial wellness tools to get account holders on their pathway to financial freedom. With rising living expenses, families have to prioritize which costs are basic needs for their household. This conflict makes it incredibly difficult for consumers to make the right financial decisions. In fact, “only 34 percent of Americans can answer at least four of five basic financial literacy questions,” (Possible Finance, 2021). With a renewed focus on financial literacy, FIs can empower their users and help them begin to experience greater financial health.
How can FIs support consumers who rely on overdraft services?
Even though digital banks and megabanks benefit from account holder growth with the appeal of no overdraft fees, there is a light at the end of the tunnel for FIs. Regional and community FIs have a deeper understanding of what their users truly need. By offering financial wellness tools, FIs can take a proactive approach to help their users with financial management, which could lead to better financial health and lessen demand for overdraft services.
FIs should create proactive and reactive strategies to deliver liquidity solutions to their users.
In an episode of the American Banker podcast, they explored the challenges FIs experience with overdraft fees and gave an overview of potential services FIs can provide to their users who need faster liquidity. Some of their strategies include:
- Introducing early direct deposit, which enables users to access their paychecks up to two days early for a nominal fee. This may be a good option for individuals who need to pay hefty bills, like rent or mortgage payments, in a time-sensitive manner.
- Extending a line of credit for individuals who have a near prime or prime credit score.
- Offering protection products that would ensure overdraft services while driving FI income.
Customers and members want timely advice to support their savings efforts. By taking a user-advocacy approach, FIs can strategically position themselves as a trusted advisor for their users with transparent communication and educational services. Pairing advice with intuitive financial wellness tools empowers users to make smarter financial decisions while avoiding overdraft fees.
By partnering with Alkami, FIs can deepen account holder loyalty with free education, a central view of their finances via account aggregation, and relevant insights into their savings, spending, and credit score. Additionally, Alkami’s marketing & analytics solution empowers FIs with data insights and machine learning that contextualizes the users’ financial behaviors. These insights can then be leveraged to deliver targeted offers for additional products based on the users’ unique needs.
While the evolution of overdraft fees is to be determined by government regulations, FIs have been actively engaged in conversations about how this will impact their operations. The top digital banks are changing their fee structure, leaving FIs concerned about their inevitable future and searching for new sources of income. If FIs can work with their account holders to understand their need for overdraft protection, they can identify the cause, provide resources and recommendations to help them overcome their financial challenges, and as a result build trust, improve customer or member satisfaction, and drive user loyalty.