Paper Examines Overdraft Regulation and Markets in US, UK, and Israel

Harvard SJD candidate Aluma Zernik has written When Markets, Consumers and Regulators Collide: Overdrafts in the US, UK and Israel. Here's the abstract:

There is a fierce debate in the US about whether to regulate overdrafts and, specifically, about whether overdraft should be limited or prices should be capped. Proponents of regulation claim overdrafts are not marginally priced and cause financial harm. Opponents of regulation claim that capping overdraft prices will harm consumers by limiting access to overdraft credit and protection against rejected transactions. This paper conceptually unpacks some of these claims, while comparing the overdraft markets in the US, the UK and Israel. First, I argue that overdrafts can, and do in fact fulfill three different functions: (i) unintentional overdrawing and insurance against the rejection of transactions (ii) short-term high-cost credit and (iii) long-term revolving credit lines. This distinction sheds light on the differences in pricing structures between countries and how overdrafts compete with alternative financial products. Thus, while prices in the US may be non-marginal when compared to short-term high-cost credit such as payday loans, competition with credit card companies might explain why overdrafts in the US aren’t provided as long-term revolving credit at significantly lower prices, as is the case in Israel and the UK. Additionally, this distinction raises the need for more fine-tuned regulation, acknowledging that different functions and pricing structures of overdrafts trigger diverse market failures, cognitive biases and mistakes. The harm from inadvertent overdrafts could be mitigated with the use of technology and real-time notifications, and cannot be detached from the prices of insufficient funds charges and other forms of overdraft protection such as credit lines. When overdrafts are used as emergency, short-term funds, they should be compared to other short-term high-cost credit, such as payday loans. Since banks have significantly lower overhead and risk-based costs, this indicates banks may be charging excessive prices, while exploiting consumers’ insensitivity to prices and underestimation of their future financial hardship. Finally, while consumers in the UK and Israel may benefit from lower prices for inadvertent overdrafts and long-term credit, the design features of overdrafts as revolving credit with no clear repayment date might reduce consumers’ welfare by limiting their ability to devise self-control mechanisms, exacerbating overconsumption and leading to high, chronic, and persistent levels of debt.

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