The Data Desk — Cumulative Impact: What Do Reg. II and Overdraft Proposals Mean for Consumers and Consumer Banking?

If it seems like the landscape has shifted in financial regulation, that’s because it has. In both their numbers and scope, recent regulatory proposals – including the Consumer Financial Protection Bureau’s (CFPB) overdraft proposal and the Federal Reserve’s Regulation II (Reg. II) debit interchange proposal – independently present hurdles to providing low- to no-cost consumer checking products. Cumulatively, however, these proposals impact how banks do business and undermine banks’ ability to serve all consumers.

In this post, we analyze the cumulative impact of two specific regulatory proposals on consumers– the CFPB’s proposed overdraft rule and the Federal Reserve’s update to Regulation II – being realistic about what we can and cannot estimate.

How We Did This

1. Creating a hypothetical (yet realistic) large regional bank to understand the likely impact these rules would have;
2. Estimating the impact of the two rules on this large regional bank’s revenue and costs;
3. Evaluating checking account revenue by consumer segments; and
4. Estimating the pass-through impact of revenue reductions on each segment’s annual net profit/loss per consumer.

Based on our analysis, these two proposals together could result in 30 to 50 percent of consumers at a typical large regional bank losing access to low- and no-cost checking products.¹ 

Step 1: Creating a hypothetical large regional bank

To conduct our analysis, we first created a hypothetical large regional bank using 2023 Call Report information from banks with $250 to 500 billion in assets.² We focus on these institutions as they are likely less insulated from revenue impacts compared to larger institutions, have similar products and services compared to smaller banks, and are well above the proposed or established asset thresholds in each rule ($10 billion or more in assets).

For this analysis, we look at the impact to revenue on checking accounts.  At a high level, the basic building blocks of bank revenue from consumer checking accounts come in the form of net interest income and fee income—which together, account for nearly all the revenue a bank earns through its checking account portfolio. This revenue can come with many costs including branch staffing and location costs, call center operations, marketing, product development, overdraft losses, and fraud losses and prevention to name just a few.

Let’s imagine that you are the Head of Retail Banking or Deposits for a large, regional bank. You look at the current checking portfolio and see that net interest income (the difference between what banks pay on a deposit and what they earn using that deposit to invest in other assets, like loans) is up considerably compared to last year, overdraft income is down considerably after your bank introduced next-day-grace and a $50 buffer to compete with your peers while keeping the fee at $35, and other fees like maintenance, ATM, and debit interchange are flat year-over-year. 

At the end of the day, you have done your job well if the bank is earning a net operating profit from the consumer checking portfolio.

Step 2: Estimating the impact of the two rules on a large regional bank

Enter the CFPB’s proposed overdraft rule and the Federal Reserve’s proposed update to Regulation II.

Overview of Proposed Rules for Overdraft and Regulation II:

• In general, the CFPB’s overdraft rule, if finalized as proposed, would subject overdraft services provided by banks and credit unions with more than $10 billion in assets (“large banks”) to credit regulations under the Truth in Lending Act (TILA). This would apply if a bank or credit union’s fees for honoring overdrafts exceed their direct cost of providing the service, including any associated charge-offs, or a price cap set by CFPB of $3, $6, $7, or $14.  Smaller banks (those under $10 billion) could continue offering overdraft in its current form.
• The Federal Reserve is tasked with setting the maximum for interchange fees generated by debit cards (the fees merchants pay to banks and care network operators like Visa per debit card swipe) in Regulation II (“Reg II”). Interchange rates are currently capped at an average of 23 cents per transaction.³ In 2023, the Federal Reserve proposed changes to Reg. II that would effectively reduce the average interchange fee by an additional 23 percent.⁴

You, as Head of Retail Banking of our hypothetical bank, are now tasked with understanding how the CFPB’s proposed overdraft caps of $3, $6, $7, and $14 and the Federal Reserve’s reduction of your debit interchange revenue will impact your business. You pull up the bank’s income statement and get to work.

Holding all else equal (interest expense, provision, securities gain/loss, non-interest expense, etc.) the results show that⁵:

• The new Reg. II cap and $14 overdraft cap produce a nearly $211 million drop (nine percent) in net income.
• The new Reg. II cap and $7 overdraft cap produce a nearly $265 million drop (11 percent) in net income.
• The new Reg. II cap and $6 overdraft cap produce a nearly $272 million drop (12 percent) in net income.
• The new Reg. II cap and $3 overdraft cap produce a nearly $295 million drop (13 percent) in net income.

In all the above scenarios, the overdraft cap accounts for approximately 80 percent of the drop in net income, and the restriction on interchange fees accounts for 20 percent of the drop in net income (see Table 1 below).

Table 1: Drop In Net Income At New Reg. II and Different Overdraft Fee Caps

Step 3: Evaluating checking revenue by consumer segments.

“So what if a bank makes less money? Less fees means consumers save more, right?”

While this can be an understandable conclusion, it fails to acknowledge the reality, and the complexity, of consumer checking economics.⁶ Revenues, costs, and margins on consumer checking accounts vary by consumer. Artificially capping revenue requires that banks either operate at a loss, charge fees somewhere else, stop offering the product, or find alternative means of funding—each of which would have negative impacts on consumers and the market.  

In the consumer checking space, margins can be thin and competition fierce.⁷ As margins become thinner and thinner due to artificial price caps, it can be increasingly difficult for banks to serve their entire customer base (Price caps, by design, limit a bank’s ability to cover the cost to serve each customer.)

Evaluating the extent to which the CFPB’s proposed overdraft and Federal Reserve’s Reg. II price caps negatively impact the ability of banks to serve their customer base requires understanding two main aspects:

1. How revenue is generated; and
2. How revenue compares to the cost of serving consumers.

1. How Revenue is Generated

Checking account revenue generally comes from a few sources: net interest income and fees, including overdraft; debit interchange; maintenance fees; ATM fees; and other fees. However, these sources of revenue are not generated evenly across all checking accounts in a bank’s portfolio.

The way people bank varies. The way they generate bank revenue equally varies. Some people will use services like overdraft and ATMs, while others will rarely do so. Some consumers keep large balances in their checking accounts month to month and others do not.  As a result, different groups of consumers generate different amounts of revenue from each source.  For example, fee revenue is generated more from one group of customers while other revenue like net interest comes largely from a different group.

Because consumer checking revenue can be spread unevenly across a bank’s portfolio, regulations that artificially cap different revenue streams can have differing, outsized impacts on particular consumer populations. 

To account for this in our analysis, we break out bank checking account portfolios by balance tiers (consumers who keep above or below a certain average balance in their account each month), with certain revenue streams being highly correlated with different balance tiers.

To keep things simple, we have broken out checking accounts into two main tiers:

• Mass market consumers (average monthly balance below $5,000 or $2,500); and

• Non-mass market consumers (average monthly balances above $5,000 or $2,500).

CBA has found that, on average mass market consumers generate a higher share of all fee revenue, including debit interchange and overdraft while non-mass market consumers generate a bulk of net interest income.

This breakdown is largely driven by mass market consumers having relatively lower balances, both increasing their chance of needing to use overdraft to cover purchases when liquidity is constrained and decreasing the amount of net interest income they can generate. Additionally, mass market consumers more heavily use debit cards and fee-based services like ATMs, increasing their share of fee revenue relative to other consumers.⁸ Conversely, non-mass market consumers keep much higher balances month to month and thus are the primary source of net interest income for most banks and generate much less overdraft revenue. They also tend to favor credit cards over debit cards, reducing the share of debit interchange revenue they generate from their checking account.

2. How Revenue Compares to Cost of Serving Consumers

Total checking portfolio costs are generally even across mass market and non-mass market customers. While mass market customers may generate higher overdraft losses and use branches more, non-mass market customers use bank products that cost more to facilitate on a per account basis like financial advisors whose salaries and commissions are generally higher than those of branch staff on a per unit basis. To summarize, while costs are generated differently between these two groups of consumers, the total costs for the mass market and non-mass market portfolios are generally even and are held constant in our analysis.⁹

Step 4: Estimating the pass-through impact of revenue reductions on each segment’s annual net profit/loss per consumer.

Our example of a large regional bank gives us insight into what bankers across the industry are seeing when evaluating how the anticipated Reg. II and overdraft rules will affect banks’ abilities to serve mass market consumers. 

We make the following assumptions to understand the impact more granularly:

1. The bank has about three million customers in its mass market checking portfolio (defined as people with less than a $2,500 average monthly balance);

• A $14 or $3 CFPB overdraft cap is finalized, resulting in a 60 to 90 percent drop in the bank’s overdraft revenue;¹⁰ and

• A Federal Reserve Regulation II final rule reduces the bank’s debit interchange revenue by 23 percent.

As we discussed previously, cutting debit interchange and overdraft fees materially reduces overall checking account revenues. Keeping costs constant, this reduction would create a scenario where the bank goes from making a net profit on a large portion of its checking portfolio, to making a net loss even after accounting for the fact that the bank could take a portion of this cost as a loss or find other efficiency gains.¹¹

However, this net loss is not equally distributed across all the bank’s checking account customers.

Remember, customers generate revenue differently depending on what balance tier they fall into — mass market or non-mass market. While the cost to serve both stays largely the same, the revenue for mass market consumers is severely cut, while revenue for non-mass market consumers stays relatively stable. Approximately 90 percent of the reduction in overdraft revenue and 75 percent of the debit interchange revenue lost is attributable to mass market customers.¹²

Without other sufficient forms of revenue to break even, these consumers end up generating a net loss per account. CBA’s analysis estimates that the annual net loss per mass market consumer would be between $35 to $50 for a typical large regional bank (see chart below).¹³

Conclusion

Operating at a net loss per consumer is not a sustainable business model in any industry, much less for banks, given the safety and soundness obligations they owe their depositors. The cumulative impact of the CFPB’s overdraft rule and the Federal Reserve’s Reg. II changes will result in banks operating at a net loss per mass market consumer. 

As a result, banks would need to either raise costs elsewhere or find new revenue streams to at least break even. Past research suggests this would likely come in the form of higher monthly maintenance fees for checking accounts, or increasing minimum balance requirements, reducing low-to-no-cost checking account offerings for mass market consumers, and severely impairing the progress made on serving unbanked and underbanked populations.¹⁴

Put simply, if a typical large, regional bank were to pass through just 50% of its lost revenue to break even, the annual cost for each mass market consumer would increase substantially with an estimated 29 to 42 percent increase in annual checking account fees.¹⁵

Our analysis shows that regulators cannot ignore that the costs and burdens for banks associated with regulatory proposals do not exist in a vacuum, and compounded they ironically result in harm to the very consumers these proposals are meant to help.

While CBA’s analysis does not capture the full cumulative impact of various other regulatory proposals that have been put forward, there are a myriad of proposals that, while often possessing laudable intentions, will similarly impact consumer banks and their ability to serve their customers.¹⁶

We hope this analysis serves as an example for regulators to do better, coordinate, and think about the impacts their policy choices can have. CBA looks forward to facilitating and participating in those conversations to create better policy and better outcomes for the consumers we serve.

Assumptions

Given the incomplete nature of the data used, we made a range of assumptions outlined below. We checked these assumptions with researchers and former leads in the consumer deposit businesses of various banks. We welcome additional data or insight that could improve our analysis.

1. We use a uniform distribution of total checking portfolio revenues and costs for large regional banks in our consumer impact portion of the model. We also ran additional iterations of the analysis for banks in different asset classes;
   
2. We use a distribution of different revenue streams for total revenue and split by mass market and non-mass market consumers (defined in the tables below);

3. We assume costs remain constant across periods and are generally split evenly between mass market and non-mass market segments;

4. We assume, generally, that banks in our focus segment derive a roughly even share of interchange revenue from debit and credit cards (45 v. 50 percent respectively)
   
5. Given a majority of the banks in our focus group charge $35 per overdraft, we use this as our baseline overdraft fee amount; and
   
6. We account for the fact that there may not be 100 percent passthrough of reduced revenues to consumers per findings such as those in research on the impacts of the initial Durbin Amendment by Vladimir Mukharlyamov and Natasha Sarin. Accordingly, we multiply the reduction in revenues or net loss by a passthrough coefficient similar to those in this research (0.5 or 50 percent in our model).

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¹ The Federal Reserve Survey of Consumer Finances found the median (50^th percentile) transaction account balance to be $8,000 see for example: Federal Reserve Board of Governors. Changes in U.S. Family Finances from 2019 to 2022: Evidence from the Survey of Consumer Finances. October 2023. p. 15; Table 3 at https://www.federalreserve.gov/publications/files/scf23.pdf;

See also Consumer Financial Protection Bureau. Making Ends Meet in 2023: Insights from the Making Ends Meet Survey. December 2023. p. 33; Figure 7 at https://files.consumerfinance.gov/f/documents/cfpb_making-ends-meet-in-2023_report_2023-12.pdf CFPB Making Ends Meet found that 55.6 percent of consumers had below $5,000 in both their checking and savings account.;

Additional conversations with industry analysts on the number of households in different balance tiers suggests that at least 30% to 50% of households at large regional banks hold average balances of up to $2,500 and $5,000 per month respectively, making them susceptible to the impacts described in this analysis.

² We used public Call Report information from 2023 to understand the realistic total dollar impact of the proposals on banks in different asset classes or markets in terms of net income and return on assets. We focus the impacts on a subset of banks with between $250 and $500 billion in total assets that we define as “large regional banks” (the “focus group”). CBA’s analyst team re-created the income statement of a “pseudo bank”, that is representative of banks in this $250-$500B asset range after accounting for outliers. To be sure our fictional bank was representative of reality, we ran typical profitability calculations and found that our bank’s total net income and return on average assets were roughly in line with those of the banks we were trying to replicate ($380 million and 0.62 percent respectively). These banks are typically larger regional institutions with margins that are smaller than those of the largest institutions, but similar to those of smaller “mid-tier” banks.

³ Federal Reserve Board (Table 3, 2021): https://www.federalreserve.gov/paymentsystems/regii-data-collections.htm

⁴ See, e.g., Bourke, Nick, How Proposed Interchange Caps Will Affect Consumer Costs (January 24, 2024). Available at SSRN: https://ssrn.com/abstract=4705853 or http://dx.doi.org/10.2139/ssrn.4705853

⁵ Results may vary for a specific bank over a specific time period. See Assumptions 4 and 5. We assume, generally, that banks in our focus segment derive a roughly even share of interchange revenue from debit and credit cards (45 vs. 50 percent respectively). Given a majority of the banks in our focus group charge $35 per overdraft, we use this as our baseline overdraft fee amount.

⁶ See Assumption 2; We broke down consumer checking revenue into distinct categories using the Call Report information including net interest income, overdraft fees, debit interchange, and maintenance and other fees to isolate the impacts of the regulatory proposals.

⁷ See for example: US bank profits fall as competition for deposits erodes lending margins. Reuters. January 2024. at https://www.reuters.com/markets/us/us-bank-profits-fall-competition-deposits-erodes-lending-margins-2024-01-17/;

Banks leverage high-cost products to attract deposits as competition intensifies. S&P Global. June 2023 at https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/banks-leverage-high-cost-products-to-attract-deposits-as-competition-intensifies-76215128;

Higher Deposit Costs Continue to Challenge Banks. Federal Reserve Bank of St. Louis. September 2024. at https://www.stlouisfed.org/on-the-economy/2024/sep/higher-deposit-costs-continue-challenge-banks 

⁸ Berhan Bayeh, Emily Cubides and Shaun O’Brien. (2024). 2024 Findings from the Diary of Consumer Payment Choice. The Federal Reserve. Retrieved from https://www.frbservices.org/binaries/content/assets/crsocms/news/research/2024-diary-of-consumer-payment-choice.pdf

⁹ We note that overdraft losses may or may not change as a result of the CFPB’s rule. For instance, a bank could reduce access to the product for certain consumers, thus reducing losses and thus costs, however, our analysis cannot predict what banks would or would not do to their overdraft programs. Further research is welcomed on this topic.

¹⁰ Dropping the original $35 to $14 or $3 and holding all else equal would mechanically reduce revenues by 60 percent  or 90 percent respectively.

¹¹ See Assumption 6; We multiply new net cost totals by a pass-through coefficient equal to 50% (θ=0.5) to account for the fact that not all net losses will filter through to consumers and that some will be absorbed by the bank

¹² See Assumption 2

¹³ We modeled what the new revenues in each would be for each consumer segment given the proposals and subtracted it by their respective costs to obtain total net cost figures for the mass market consumer checking segment; We subject our findings to sensitivity analysis to understand the circumstances in which the regulatory proposals would continue to produce net profits per consumer rather than net losses, finding that all combinations of the proposals produce some level of net loss per consumer; Ranges are based on losses at the $3 to $14 overdraft fee cap and after running scenario analyses.

¹⁴ Mukharlyamov, Vladimir and Sarin, Natasha, Price Regulation in Two-Sided Markets: Empirical Evidence from Debit Cards (November 24, 2022). Available at SSRN: https://ssrn.com/abstract=3328579 or http://dx.doi.org/10.2139/ssrn.3328579

¹⁵ Using the average monthly maintenance fee of $10 to obtain an annual cost of $120, we estimate that annual costs would increase to between $155 and $170 a year or 29 to 42 percent annually to cover net losses.

¹⁶ Additional examples include, but are not limited to revisions to the Federal Reserve Board’s Basel III proposal, the CFPB’s credit card late fee rule, the CFPB’s revisions to Dodd Frank Act Section 1034(c), FDIC rules regarding brokered deposits, costs associated with implementing the CFPB’s Dodd Frank Act Section 1071 and Section 1033 rulemakings, and others.