Consumer Susceptibility to Bank Overdraft Fees: Evidence and Implications
University of Central Florida
Even in 2001, Soman noted the dizzying array of payment mechanisms available to consumers. While traveler’s checks have vanished, many more mechanisms have emerged—near-field communication (NFC) payment methods like Apple and Android Pay, mobile apps, Bitcoin, PayPal, and digital gift cards, to name a few. Nevertheless, the factors that Soman (2001) experimentally substantiated remain—the “learning and rehearsal of the price paid” and “immediacy with which wealth is depleted” (p. 466). Cash has both, paper checks have the former, and credit cards and many emergent payment methods have neither. The presence of these factors makes spending painful, while their absence encourages buying by making it less real, including by bundling the purchases together to be paid at a later date. However, a consideration Soman (2001) did not examine is that debit cards’ direct connection to one’s bank account engenders delinquency and overdraft fees—a fee of about $35 a bank charges for your account going negative. At times, immediacy can do this—a credit card is paid monthly in a lump sum, which gives just one opportunity for overdraft. At other times, delayed or recurring debits, due to their lack of immediacy and/or variability in cost, can cause costly overdraft fees.
Stango and Zinman (2009, 2014) lament that consumers pay an annual average of about $150 per checking account in overdraft fees, and more than half of these are “avoidable,” meaning the consumer has funds available elsewhere that could have paid for their purchase. They recruited panelists who not only completed questionnaires, but also provided access to their transaction-level checking account data. Their 7448 panelists participated for a median of 16 months, with over 95% reporting having only one checking account. A majority (52%) incurred an overdraft fee during the panel or in the past. Questionnaire responses revealed that 60% attributed overdrafts to mental overestimation of available balance, while the remainder generally reported deposit holds or other unexpected liquidity irregularities. An economist who erroneously models humans as rational maximizers might surmise that consumers pay overdraft fees because the marginal utility of the debit exceeds the sum of the debit amount and overdraft fee—but Stango and Zinman’s (2014) data and questionnaires point toward a limited attention model, meaning consumers simply are not paying close enough attention to their checking accounts. However, drawing consumers’ attention to overdraft fees via questionnaires was found, by examination of their transaction-level bank data, to result in fewer overdrafts in subsequent months.
Employing the inattention model, one is empowered to advocate for regulatory reform to improve social welfare (Grubb, 2015). The Federal Reserve took an important step when they required banks to make opting in the requirement for overdraft protection on debit cards. This nudge (Thaler & Sunstein, 2008) prevents many overdrafts, and the requisite fees, at the point of sale. However, it does nothing for recurring intrabank transfers, automated clearinghouse transactions, or checks, all of which may still trigger overdraft fees. Notably, in addition to attention, quantitative literacy and numerical skills have been shown to positively correlate with financial behaviors that are future-oriented, rather than impulsive (Nye & Hillyard, 2013).
Lusardi and Mitchell (2014) discuss a saddening finding from the U.S. Financial Capability Study (www.usfinancialcapability.org): While 70% of Americans rate their financial knowledge highly, only 30% can actually answer a small number of quite basic financial questions correctly. Less education and being in a vulnerable group, such as African Americans, women, young or old, and rural residence, are all correlated with less financial literacy and by consequence, susceptibility to overdraft fees. At a macro level, this undermines American economic stability and perpetuates wealth inequality, including the subjugation and disenfranchisement of vulnerable and protected groups (Lusardi, Michaud, & Mitchell, 2017).
Implications and More Evidence
Here is a simple inductive leap: If consumers cannot even manage their bank accounts prudently, how can we expect them to accumulate wealth judiciously and copiously? “Retirement”—which might be characterized as a prolonged period of reduced earnings subsidized by decumulation of capital—is a pricey proposition. Financial literacy education (FLE), or, providing students and consumers with general-purpose instruction on relevant financial topics, intuitively appears to be a practical and effective solution.
However, L. E. Willis argues, with astonishing prolificacy, that financial literacy education (FLE) is misguided and pointless (e.g., Willis, 2008). A law professor, she paints personal finance as a fast-moving river where yesterday’s advice—and regulations, for that matter—are soon stale and even detrimental, in part because the financial services industry prospers on complexity and chaos. For example, adjustable-rate mortgages were rare before the mid-2000s, and sadly, homebuying education only warned strenuously about such mortgages after the crisis. Of course, mistaking your mortgage broker for a fiduciary (i.e., Ross & Squires, 2011) transcends FLE—avoiding confidence tricks requires a different set of psychosocial skills that only partially overlaps with financial literacy.
While it would be disingenuous to depict Willis’s dourness as more than a fringe view, the coalition behind FLE can rightly be depicted as Pollyannaish—or even, in certain quarters, diabolical (cf. English, 2014). When Fernandes, Lynch, and Netemeyer (2014) completed their meta-analysis of FLE interventions, they found FLE curdles like milk—even sprawling, semester-long courses do nothing to improve behavior two years in the future. In fact, complementary to Willis (2008), they propose to disembowel FLE right in their abstract— “just-in-time” FLE is their neutered, potentially-useful alternative. Even Lewis Mandell, professor emeritus, at the forefront of financial education and research for over 40 years, in 2012 called for a moratorium on mandatory financial literacy courses in secondary school, because “successful implementation of [financial] educational programs has not occurred” (Mandell, 2012, p. 107)— they simply do not work as presently conceived.
What We Can Do
In the field of instructional design, there is a widely voiced reverence for principles over technology. While technologies are like rapids, principles—such as the alignment of assessment tools with learning objectives—are timeless. In a similar vein, to encourage avoidance of bank and credit fees, we might focus on teaching strategies rather than financial content. For instance, numeracy and quantitative literacy are important (Nye & Hillyard, 2013), yet distinct from FLE and perhaps not actually taught in most FLE programs.
Ironically, Willis (2009) proposes a promising yet untested alternative: financial norms education (FNE). FNE principles, or benchmarks, are more accessible, memorable, and require less cognitive load (e.g., Drexler, Fischer, & Schoar, 2014). For bank fees, you could start with a piece of empirical evidence from Stango and Zinman’s (2009, 2014) research: 83% of panelists who incurred overdraft fees regularly let their balance slip below $100, while only 56% of panelists who did not incur overdraft fees did so. Consequently, a teachable benchmark would be to maintain a cushion of at least $100 in your checking account. Instructionally, you could integrate this with stories and videos from individuals who did not keep $100 in their checking account, and suffered the consequences.
The inattention model (Grubb, 2015; Stango & Zinman, 2014) serves as a useful and empirically supported framework for characterizing susceptibility to overdraft fees. In fact, it could be applied to many other personal-finance issues such as late payment fees, not knowing terms of loans or interest rates, failure to shop around for insurance, and misplaced priorities when acquiring income, making purchases, or paying debts. Surprisingly, if we compare to Fernandes et al.’s (2014) findings, salience—merely bringing a matter to the student’s attention—may be more important than education when it comes to overdraft fees.
Finally, credit unions—which are widespread, not-for-profit alternatives to banks—might borrow a page from Thaler and Sunstein’s (2008) “nudge theory” by displaying members’ checking account balances in red with a warning message when below $100. We can expect Bank of America to continue their Better Money Habits educational program—corporate citizenship has little cost if Fernandes et al. (2014) holds true. However, being that bank overdrafts are a $30–40 billion annual industry (Stango & Zinman, 2014), nudging customers away from making the bank money is a hard sell to executives and shareholders. Thus, we might suggest another benchmark to financial students: Join a credit union. Even if FLE is dead, the outlook for research, innovation, and real progress in financial education are optimistic—but only if effective strategies are employed.
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