What About Dynamic Limits?

The concept of ‘dynamic overdraft limits’, where different customers get different limit amounts based on purported risk, was developed for very large FIs,  with the primary goal of reducing risk, with little regard for consumer convenience or fee income. At Strunk we believe dynamic limits are a bad idea.

First let’s talk about risk versus reward. Risk associated with overdraft protection is typically the same or less than what we are familiar with on the lending side of our business—but our margin is higher. Under any scenario, the loss experience on overdrafts relative to revenue is a fraction of what is experienced in any loan portfolio. With overdrafts, when we manage down charge-offs too tightly, we end up managing down revenue and income even more. Focusing on the risk from overdrafts is focusing on the wrong side of the income statement.

The second issue is the effectiveness of dynamic limits in reducing risk. It might make sense to change the availability of overdraft protection based on prior history or credit score. Assuming all you care about is reducing charge-offs without regard to the impact on fee income, it might make sense to take people out of your program who demonstrated higher risk levels. But why would you change their limit? If you are comfortable with the risk, then give them a limit, but if you are not comfortable you should be giving them a limit of zero. And this whole argument assumes you have a valid model for predicting charge offs in the first place!

The third issue is use. For your program to be of any use to the consumer and to make money, you need to be giving limits to those who will make use of the program. There is not a lot of value created for anyone when you assign large limits to your best customers who never overdraft. We believe that the parameters most banks are using to assign dynamic limits are actually negatively correlated with overdraft usage, so dynamic limits have the effect of making the program less useful to those who need it most and hence lowering fee income.

The final issue is disclosure. If you are constantly changing your customers’ limits, you have the headache and expense of keeping them up to date. And even if you are effective in keeping them up to date, the effect of changing limits on the consumer will be to discourage usage, because the consumer is just not sure or can’t remember what his limit is at the moment.

Because we have such extensive experience implementing ODP programs across the country, and because of our ongoing relationships with all of the regulatory agencies, we are well positioned to ensure that the practices implemented by your institution are fully compliant and will not lead to increased regulatory scrutiny, regulatory criticism, or claims of unfair, deceptive, or abusive acts or practices. It’s easy to come up with a marketing idea to improve fee income – it’s not so easy to be certain that idea won’t result in regulatory backdraft. The potential revenue gain – if any – has to be considered in the context of the potential regulatory risk. What we might think is a good marketing idea, they often see as coercion.

Strunk has implemented more overdraft programs than any other provider in the industry. We believe that overdraft programs are a huge convenience for your customers, in addition to their benefit to your net fee income. To be effective for consumers and minimize the risk of regulatory violations or nuisance law suits, they need to be simple.