Staying out of the red: automatic bank alerts reduce costly overdrafts

Toronto - The high fees and interest racked up by bank customers when their accounts go into deficit drop significantly when they are automatically signed up for alerts warning they’re heading into the red, new research has found.

In Britain, where the research was done, that adds up to potential annual customer savings of £170-240 million Low-income customers are among those who benefit most.

In 2018, the British government began requiring major banks to issue automatic alerts to customers without prearranged overdraft agreements whenever their accounts went negative in a bid to stem annual customer charges of £2.6 billion.

Keen to understand how to optimize the program, regulators invited a research team to assess the financial behaviour of more than one million customers at two large banks that were trialling the alerts prior to the deadline for the change.

Charges for overdrafts and insufficient funds were reduced by as much as 19 per cent after the automatic alerts began, the team found. The most effective alerts were those sent right just as someone was slipping into overdraft instead of ones sent further in advance.

Two of the researchers had previously investigated the benefit of alerts for cellphone customers at risk of overage fees. “We felt that overdraft fees might be an even bigger problem, because banks often hid from customers the fact that these fees even existed,” said researcher Matthew Osborne, an associate professor of marketing at the University of Toronto Mississauga, cross-appointed to the Rotman School of Management.

Prof. Osborne and the team estimated that the charges prior to the policy change made up 15 to 20 per cent of bank revenue. Half of the charges were paid by fewer than five per cent of bank customers. “Heavy overdraft users in poor areas averaged around £380 per year in overdraft fees, which is about two per cent of their income,” said Prof. Osborne.

Large British banks had already been required since 2012 to offer customers the option to receive overdraft alerts but fewer than 10 per cent of customers accepted. A similarly low number of customers chose to opt out of the alerts in the research experiment. In a follow-up survey, most customers found the alerts helpful and more than two thirds reported taking action after getting one, such as by moving money from savings into their chequing account, borrowing from someone else or cutting back spending.

Much less common was switching the debt to their lower-cost credit cards, a topic ripe for more study, the researchers wrote.

The results suggest that most people fall into overdraft unintentionally and not because they prefer borrowing at the higher rates over other options. As a result of the research, the British government expanded the types of banks and overdraft that were covered by the alerts, put limits on what customers could be charged and required greater transparency in how the costs were explained. 

“Yes, bank customers should keep track of their money,” said Prof. Osborne.  However, “they need tools to do it.”

The study appears in the Journal of Finance with co-authors Michael Grubb of Boston College. Darragh Kelly of Google. Jeroen Nieboer of Deliveroo and the London School of Economics, and Jonathan Shaw of the Financial Conduct Authority and Institute for Fiscal Studies.

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For more information:

Ken McGuffin

Manager, Media Relations

Rotman School of Management

University of Toronto

E-mail: mcguffin@rotman.utoronto.ca