Thursday, January 28, 2010

Many Bank Fees Should be Considered Interest Charges

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.

9 comments:

  1. It was interesting to see the bank lobbyist try to explain the rationale for ordering the purchases from highest to lowest.

    He claimed it was in the consumer's interest and that customers have told the banks that's the way they want it. Oh, he says, not in any survey or anything, just from years of talking to clients. What a crock.

    Let's see... do I want to use all my available balance on a series of ten transactions before getting hit with one $35 overdraft charge, or would I rather have my balance consumed by a large transaction, then pay $350 in overdraft fees?

    It's astonishing they can re-order the transactions to maximize fees. And this is just one example of US banking transgressions.

    ReplyDelete
  2. Gene: You're right. That was a part that made me laugh out loud. I didn't believe him for one second.

    ReplyDelete
  3. By most people's standards, few bank fees are reasonable.

    Add to the fact that banks are making their income from those fees (instead of the old-fashioned way; earning it) and it's going to be next to impossible to fix the problem.

    A small start has been made, but is far too little.

    ReplyDelete
  4. Thanks for the mention Michael. I was going to comment on the point that gene raised. Hey, we charged $350 instead of $35 because that's what you've been asking us to do for years! Yeah, right.

    ReplyDelete
  5. Mark: I'm actually not against banks setting fees for services rendered. But, when it isn't really a service but is just a form of interest, we need a cap on the interest rate. Of course banks will claim that everything is a fee or "courtesy fee" rather than a form of interest. That's why we need legislators to step in and define what is and is not interest.

    CC: In that same vein, I want to assure everyone that it was years of working with ants as a kid that led me to the understanding that they actually wanted me to use a magnifying glass on them.

    ReplyDelete
  6. It's nice to read a post about bank or credit card fees that isn't just a comment from some raving lunatic at CBC.ca. Your recommendations make logical sense.

    Sounds like I'll have to make some time to watch this video sometime today.

    ReplyDelete
  7. nmm66: I find a lot of the discussion of bank fees to be reactionary and unhelpful. People seem to think that the problem with banks is the bonuses paid to top employees. This is wrong. The real problem is that the bonuses were based on false profits. If the banks had taken income charges corresponding to the risks they took, then the profits would have evaporated along with the bonuses. If a bank finds a way to be genuinely very profitable without taking undue risks and it provides useful services, then its employees deserve bonuses.

    ReplyDelete
  8. Section 347 of the Criminal Code prohibits an interest rate that is more than 60% per year. This interest includes fees but specifically not overdraft charges. I believe there was a lawsuit on the matter.

    There was a bill to reduce the amount to 35% over the Bank of Canada rate. This makes sense to me but it failed.

    Quebec prohibits pay day loans.

    ReplyDelete
  9. Aolis: Thanks for the information. So, what I'm calling for then is an expansion of what is considered interest to include overdraft charges and other "courtesy fees" invented by lenders to get around the 60% legal cap.

    ReplyDelete