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From penalty fees to proactive engagement: How banks are transforming overdraft response

June 20, 2022

  • Banking
  • Customers
  • Debt

Jody Bhagat, President of Americas, Personetics

The overdraft landscape in the US is at a watershed moment, with banks and credit unions alike taking action to lessen customer impact from overdraft and NSF penalty fees. For a long time, overdraft fees have been ‘in the shadows,’ often perceived as a penalty fee disproportionately applied to those who can least afford to pay.

by Jody Bhagat, President of Americas, Personetics

Market forces and regulatory pressure are moving the industry in a positive direction, and it’s encouraging to see the industry’s rapid response to lessen penalty fee impact with a range of customer-friendly approaches to overdraft response.  The range of response thus far can be characterized by the 4P’s:

Policy: Eliminate overdraft fees (Capital One, Ally, Alliant)
Price:  Reducing or eliminating overdraft or NSF fees (B of A, WFC)
Process: Changes to accommodate grace period or negative buffer (PNC Low Cash Mode)
Product: Creative enhancements to address the majority of situations (Truist One, Huntington Stand By Cash)

The next breakthrough in overdrafts for the industry is to address the 5t P: Proactive.  Proactive cash flow management helps anticipate and resolve overdraft situations prior to occurrence and allows for tailored customer treatments.  Rather than determining which fees to reverse, banks can focus on what tailored treatment can help this customer address a future overdraft condition and improve their financial wellbeing in the process. What if overdraft response was something that your institution was excited to promote to customers, in a way that puts the customer at the centre of the conversation?

Rather than simply a defensive move, forward-looking institutions can use this moment as an opportunity to reinforce a customer advocacy approach, where the institution becomes a trusted advisor. With inflation at a 40-year high and many families struggling with cost-of-living pressures, it’s more important than ever for banks to support customers and improve their financial wellbeing.

Here are a few reasons why overdraft response can become a bigger source of differentiation and competitive advantage for financial institutions.

Data is king: A new opportunity to understand your customer

Before you can solve overdraft conditions, it’s important to understand which customers are vulnerable to overdrafts, and what is the root cause. Overdraft conditions can become a moment of opportunity to take a closer look at what is happening in that customer’s life, and engage with the customer in a meaningful, personalized way.

Financial institutions are taking a closer look at which customers are most likely to overdraft, and why. By leveraging advanced data and analytics, banks can proactively engage the 4-6% of customers who overdraft on a monthly basis.

From our analysis, we found four common personas experiencing overdraft situations:

  1. Paycheck to Paycheck: Jim is experiencing multiple cash flow crunch situations every quarter and overdrafts repeatedly. Jim’s income may be volatile or barely enough to cover expenses.
  2. Hardship: Martha has experienced a recent hardship (e.g. income loss or significant medical expense) that is likely to create a near-term overdraft situation and a running up of credit lines.
  3. Mismanaged Timing: Tom has mismanaged the timing of their deposits and payments for a given month, resulting in an overdraft condition.
  4. Affluent Mistake: Jen has plenty of deposits with the bank but unwittingly got caught in an overdraft condition with an account.

Identifying your customer profiles and the context of each overdraft situation can help banks provide the right solution and support for each customer’s financial circumstances. By cleansing and analyzing transaction data, banks can readily understand the context of the overdraft situation. With advanced data and analytics, the bank can identify customers who are at risk for overdraft conditions, and proactively provide treatment options to support the customer’s financial needs, such as an overdraft protection solution with a connected savings account, or a short-term line of credit.

Context is queen: providing tailored treatments for overdraft at scale

Instead of just a penalty fee, overdrafts can be a way to better understand the individual customer and improve their financial well-being. By proactively engaging customers on cash flow issues, banks can reduce the number of overdrafts and negative balance situations and build stronger relationships, leading to higher customer satisfaction and loyalty.

By modelling customers’ cash flow patterns and applying a “robust” balance forecasting algorithm, banks can analyze customers’ historical, scheduled, and patterned activity to accurately identify when they are likely to have a low or negative balance prior to their next likely deposit. That way, banks can help anticipate a customer’s liquidity issues, determine why it is occurring, and proactively provide options to address the situation.  Through back testing of our model, we’ve found that we can accurately anticipate approximately 70% of overdraft conditions.  With this kind of knowledge, banks can unleash their creativity in offering treatment conditions based on the customer context and the likelihood of overdraft.

Building deeper customer relationships

Overdraft fees have represented a meaningful amount of net income for banks (6-7%) and some have been reluctant to forego that revenue. However, a customer-centric overdraft program could be an even more sizable opportunity for financial institutions by deepening customer relationships

Over the coming year, we’ll see more banks leaning into their overdraft response and seeking a more proactive solution along with reactive actions. Forward-leaning institutions will look at it not as a defensive move to avoid regulatory scrutiny, but as part of a broader proactive approach where the bank operates as a trusted advisor that helps people with their money management.

The time for banks to act is now. As inflation and the cost-of-living crisis rage on, the institutions that adapt their policies with customers front of mind will not only help to improve financial health, they’ll gain lifelong customers in return.

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