PBS aired a very interesting story called The Card Game that takes a look at bank practices that exploit people when they start to have money problems (see the Canadian Capitalist site with the conveniently embedded video). The story explained some of the more unpleasant practices and debated whether they should be stopped. Another concern was how they could be stopped without undermining free enterprise.
One of the slimier practices described was overdraft fees on debit cards. In the example given, a consumer doesn’t realize that his bank account balance is low and goes about his business for a month making debit purchases. The bank then takes all the debit transactions, reorders them from biggest to smallest so that the account is drained on the first few transactions, and then charges a $35 fee on each overdraft transaction. So, a $5 coffee becomes a $40 coffee.
This is a very nasty practice clearly designed to severely punish the unwary. There is no reason to believe that the bank’s exposure to a potentially bad loan is any different if the consumer makes one $50 debit charge instead of ten $5 charges. Yet the overdraft fees are $350 in the latter case instead of only $35.
I think the answer here is to declare (by law) that the overdraft fees are a form of interest and that interest should be capped at some usurious level, such as a nominal 60% per year (5% per month). This would permit the bank to charge 5% interest on overdrafts each month, but this would amount to only 25 cents on a $5 coffee each month rather than a one-time fee of $35.
The same idea could be applied to exceeding the credit limit on a credit card. If the fee for going over your credit limit were declared a form of interest, then it wouldn’t be possible to hit consumers with excessive over-limit fees each month. The fees would have to be proportional to the extent of the excess debt.
I’m not suggesting that we let debtors off the hook. I just want the punishment (in the form of charges) to fit the crime. It makes no sense to offer “overdraft protection” and then charge $35 for $5 of overdraft. This is a 700% penalty.
It can be a difficult challenge to determine which charges are legitimate fees and which are really just a form of interest charges. When a bank has legitimate costs resulting from some consumer’s action (such as bouncing a cheque), it makes sense to charge a fee that shouldn’t be considered interest. However, overdraft fees seem to me to be obviously just a form of interest.
I would like to see legislators in both Canada and the US define what is considered interest more broadly and set some interest rate ceiling, such as a nominal 60% per year.