Title: New Risk Profile: The Flap over Bounce Protection Demonstrates Clearly the New Breed of Compliance Risks Banks Face. (Compliance Clinic)
Abstract: On January 22, the New York Times ran the headline, Encourage Overdrafts, Reaping Profits. The article, by Alex Berenson, opened with this sentence: At least 1,000 banks are encouraging customers with low balances to overdraw their checking accounts, allowing the banks to skirt credit laws and collect billions of dollars in new fees. Voila--an instant consumer issue! It's too early to tell whether this controversy will legs, as they say in politics, but phone and e-mail lines were smoking within hours of the article's appearance, as players in industry, activist groups, and government were suddenly talking about it. The article focused on an only relatively new, but fast-growing service, in which banks cover their customers' check overdrafts for a flat fee per check, typically about $35. [In February, the latest ABA/ABA Banking Journal Community Bank Competitiveness Survey found that nearly half of the community banks responding either offered or planned to offer this service, and that seven out of ten found it a significant revenue generator.] In some cases, banks have actively promoted this service as a boon to customers worried about returned checks. In others, they have simply included the protection in the terms of basic checking accounts, catching some customers by surprise when the fees hit. The situation is a ready-made case study on the new generation of risks facing banks in today's consumer world. As I have argued before, technical and examination problems are shrinking as a share of regulatory risk. This is not because they are shrinking, but because they're being pushed aside by a fast-growing new breed of risks that arise outside of the set regulatory framework. These new pitfalls blindside banks with enforcement actions, litigation, and reputation damage triggered by practices that the bank believed to be both legal and ethical, but that turn out to be controversial. Banks need to learn to recognize the earmarks of such practices and to assess and manage these risks before they erupt. The bounce protection issue offers a valuable checklist of risk factors to watch for. RISK FACTOR: 1 It's not Illegal...or is it? A hallmark of a new-risk issue is that once it boils into controversy, people start thinking not only about whether it should be outlawed, but also about whether it might possibly have been illegal, all along. In this case, the Federal Reserve has already asked for comments on whether check protection programs may be covered by credit protection laws. On other issues, banks have found themselves facing class action litigation or creative enforcement challenges, especially from activist state attorneys general, targeted at practices that are nowhere proscribed by the law. RISK FACTOR 2 It involves innovation--the market is out ahead of the regulatory machinery. One reason legality is ambiguous on bounce protection is that the service is new. Yes, it's similar to long-standing overdraft lines-of-credit, but it's structured differently. It's a marketplace innovation that came into being long after the current laws were written, and so does not fit neatly inside them. How the law applies, therefore, depends on how you look at the practice. Is bounce protection a straightforward fee-for-service? Is it a penalty fee, like a late charge? Is it akin to insurance? If it's credit, then Truth-in-Lending, state usury laws, and other credit rules potentially apply--leaving banks exposed to litigation and enforcement risk for not following them. RISK FACTOR 3 It may involve an innovation that's rapidly spreading. This is a pattern for new-risk issues. A product innovation or new fee-income idea catches on, spreads rapidly through consultants, industry conferences, or articles, and becomes widespread before regulators, compliance staffs, and other gatekeepers weigh in. …
Publication Year: 2003
Publication Date: 2003-04-01
Language: en
Type: article
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