In the past few days, both Bank of America and CitiCorp have announced that they are doing away with overdraft fees for debit cards. No longer will you be charged $35 in penalties for a $2 cup of coffee. Instead, the bank will simply reject the transaction if you are trying to make a purchase without enough money in your account.

This is how debit cards originally worked. There was no built-in overdraft protection – you either had enough money in the account or you did not. If not, there was no harm – the transaction just didn’t go through and you pulled out a credit card instead. It might be a little embarrassing in front of the clerk but it kept you from spending money you didn’t have.

That changed when banks realized that they could earn a lot of money on the overdraft fees. Almost overnight, overdraft went from an uncommon option that you could add to the account to a default that was almost impossible to unbundle from the account. Congress reeled in banks’ ability to collect many of those fees and at least these two banks have realized that it’s not worth the trouble to try to nickle-and-dime customers for what’s left. Easier just to reject the transaction and let the customer use a different card.

I think this is an excellent trend. It reestablishes the difference between a credit card and a debit card, giving each a distinct purpose. If you want convenience and deferred payment, carry a credit card. If you don’t trust yourself not to overspend, carry a debit card. Debit cards can be good for young people and others who are struggling to learn financial discipline.

That said, I have two concerns. First, where will the banks turn to replace this revenue stream? They made a lot of money on those fees. We can expect the rules to change (again) as banks adapt and find new ways to make money. We’re all going to have to watch the rules for our accounts very carefully as the banks adjust to the new regulations.

Second, debit cards still carry a far higher risk when they are stolen. Lose your credit card and you are only liable for the first $50 (assuming that you notify your bank in time, etc). Lose your debit card and the thief can empty your account of whatever balance you have in there. Before this change, I was absolute in my recommendation that there was no longer a good reason to carry a debit card. Maybe carry an ATM-only card but nothing else. Now… Well, the financial discipline imposed by these new (or newly old) debit cards might just be right for some people. Those same people will be most badly hurt if/when the debit card is stolen. What used to be a simple decision is now more complicated. If you do decide to carry a debit card, remember the risks.

Leave a Reply