NSF and Overdraft Fees in New York State: The Impact of Bank Characteristics

and Changes in Retail Payments

DILYARA BAREEVA AND KATHERINE WYATT*

NEW YORK STATE BANKING DEPARTMENT

FEBRUARY 2005

Abstract

Since the Check Clearing for the 21st Century Act was implemented late last year, there has been
concern that the shorter check processing times it promised the banks would lead to an increase
in non-sufficient funds (NSF) and overdraft fees for customers. The Banking Department recently
carried out an analysis of checking account fees at banks with branches in New York, both to set
a benchmark for study of these fees in the future and to explore characteristics and trends in
checking account fees.

The Banking Department analyzed fee information on checking accounts at approximately 50

banks across the state as background to understanding how Check 21 will impact New York
State consumers. The Department also studied the prevalence of check imaging at these banks,
reviewed these banks’ web pages, and informally surveyed their customer service departments to
learn more about checking account plans being offered in New York State. In addition, data on
service charges on deposit accounts collected by all banks with branches in New York State have
been reviewed, as a means of discussing the importance of these fees to banks. Finally, the
Department reviewed existing federal publications on NSF and overdraft fees.

The Banking Department study showed that fee structures vary between large banks and small
banks, and between upstate and downstate branches. While NSF fees have increased at all the
survey banks since 2001, larger banks and downstate banks showed greater average increases.
At the same time, bank revenues from service charges on deposit accounts – including NSF fees
-- have increased over the last few years, both nationwide and at banks with branches in New
York State. Smaller banks showed greater growth in revenue from service charges than larger
banks, and the share of income represented by service charges has grown more at smaller banks
than at larger ones.

Overdraft protection plans have grown in popularity since 2001, with all but two banks in the
survey offering overdraft protection in the fall of 2004. However, different types of overdraft plans
are available to New York consumers: some are linked to deposit accounts or lines of credit, and
some are fees for activating a loan to cover draws on insufficient funds.

Finally, the impact of Check 21 may be tempered by the decline in the use of checks and the
prevalence of check imaging, online bill payment, and ATM transactions. Almost all survey banks
use check imaging, and fewer than half of the banks surveyed in the fall of 2004 offer to return
cancelled paper checks with monthly statements. The fees associated with new payment
methods, such as point-of-sale debits and ATM overdrafts, should be monitored to ensure that
these do not reach excessive levels.

*The opinions expressed in this paper are the authors’ own, and do not necessarily reflect the
views of the New York State Banking Department.

1
Introduction and Scope

The Check Clearing for the 21st Century Act1, which allows banks to process and deliver checks
electronically, was implemented on October 28, 2004. Electronic processing of checks promises
to shorten check processing or “float” time, and could lead to more non-sufficient funds (NSF)
fees or overdraft fees being charged to customers.2 The Banking Department began this study in
fall 2004, both to establish a benchmark for future studies and to discover characteristics of these
fees.

Major areas of concern were:

ƒ the types and level of fees imposed by banks in New York State;
ƒ how New York fees compared to national averages; and
ƒ differences in the level of revenue different types of banks report from these fees.

The Department found that fees for checks drawn on non-sufficient funds as well as fees for
overdraft and bounce protection plans have risen at banks surveyed for the New York State
Banking Department, and that these fees varied depending on the size of the bank offering the
account and depending on the region the bank was located in.

Information on NSF and overdraft fees in New York State came from semiannual surveys carried
out by Bankrate.com at banks with branches in New York. Quarterly Reports of Condition and
Income for all banks with branches in New York State were studied to determine changes in
revenue from these fees and differences in share of income the fees represented.

The Department found that although NSF fees had increased statewide and nationally, there
were regional differences in fee levels within New York State, with average fees higher in New
York City and Long Island. The Department also found that banks with more than $1 billion in
assets charged higher fees than smaller banks. In other, national, studies, New York fees were
somewhat lower than average. Although larger banks charged higher fees on average, service
fees on deposit accounts represented a smaller share of non-interest income at these banks than
at smaller banks.

Overdraft protection plans have grown in popularity since 2001, with all but two out of fifty banks
in the survey offering overdraft protection in the fall of 2004. However, different types of overdraft
plans are available to New York consumers: some are links to deposit accounts or lines of credit,
and some are fees for activating a loan to cover draws on insufficient funds. The survey data did
not provide a breakdown by type of overdraft protection. Also, since overdraft fees are not
reported with service charges on deposit accounts, it is difficult to determine banks’ revenue from
overdraft programs.

The Department also studied changes in the retail payments system and the prevalence of check
imaging, reviewed banks’ web pages, and informally surveyed consumer service departments as
background to understanding the impact of Check 21 on New York State consumers.

Description of New York Survey Banks

The Banking Department has contracted with Bankrate.com to survey about 50 institutions across
the state twice a year on checking account characteristics. Survey banks include eight out-of-
state banks with branches in New York; these banks are headquartered in California, North

1
See “Check 21: What You Need to Know” at www.banking.state.ny.us for a description of the
Check Clearing for the 21st Century Act.
2
Check 21 does not change the allowed hold times for checks deposited by consumers.

2
Carolina, New Jersey, Ohio, Pennsylvania, and Rhode Island. In 2004, 431 checking accounts at
53 banks in the state’s ten economic regions3 were in the survey. These banks held 84% of total
deposits in New York State bank branches in 2004, so characteristics of checking accounts
offered by the survey banks are relevant for depositors in New York State. The survey banks
ranged in asset size from $25 million to $655 billion as of 6/30/04, and included commercial
banks, trust companies, and savings institutions. At 6/30/04, 31 of the survey’s banks were state-
chartered and 22 were federally chartered.

NSF Fees

The Banking Department found that average NSF fees have increased steadily since 2001 at the
survey banks, with larger banks and downstate banks showing greater average increases. The
statewide average NSF fee was $28.22 in Fall 2004, a 14% increase from the 2001 average
across survey banks’ checking accounts. Although NSF fees increased on average – indicating
higher or the same fees at most banks -- the minimum and maximum fees remained at $10 and
$32 respectively from 2001 through fall of 2003. In spring 2004, the highest NSF fee went from
$32 to $33, and in fall of 2004, the lowest NSF fee went from $10 to $15. Only one bank imposed
the lowest fee over this period.

NYS Average NSF Fees across Survey Banks’ Accounts

Time Period NSF Fee

2001 $24.83
Spring 2002 $25.02
Fall 2002 $24.96
Spring 2003 $26.50
Fall 2003 $27.01
Spring 2004 $27.40
Fall 2004 $28.22

Regional Differences in NSF Fees

From 2001 until Spring 2004, the highest average NSF fees were charged to checking account
customers in New York City. In Fall 2004, checking account customers in Long Island paid the
highest average insufficient funds fees. The lowest average NSF fee was levied in the North
Country region from 2001 to 2004. However, average NSF fees increased the fastest in the North
Country region over this time period, going from $21 in 2001 to $26.26 in 2004. In contrast,
average NSF fees went from $26.34 to $27.89 in the Finger Lakes region during this period.
Average fees in New York City increased only 1.25%, to $29.62. Although the regional averages

3
The ten economic development regions are: Capital (Albany, Columbia, Greene, Rensselaer, Saratoga,
Schenectady, Warren, and Washington counties); Central NY (Cayuga, Cortland, Madison, Onondaga, and
Oswego counties); Finger Lakes (Genesee, Livingston, Monroe, Ontario, Orleans, Seneca, Wayne,
Wyoming, Yates counties); Long Island (Nassau, Suffolk counties); Mid-Hudson (Dutchess, Orange,
Putnam, Rockland, Sullivan, Ulster, Westchester counties); Mohawk Valley (Fulton, Hamilton, Herkimer,
Montgomery, Oneida, Schoharie counties); New York City (Bronx, Kings, New York, Queens, Richmond
counties); North Country (Clinton, Essex, Franklin, Jefferson, Lewis, St. Lawrence counties); Southern Tier
(Broome, Chemung, Chenango, Delaware, Otsego, Schuyler, Steuben, Tioga, Tompkins counties); and
Western NY (Allegany, Cattaraugus, Chautauqua, Erie, Niagara counties).

3
 were closer at the end of this period than at the beginning, there were instances of banks
charging different NSF fees for the same named account depending on the region the customer
was in. NSF fees varied by region for several of the largest banks – Fleet, HSBC, M & T,
JPMChase – in the years 2001 – 2004. In all but one instance, customers in New York City or
Long Island were charged higher NSF fees than customers in other parts of the state. The
exception was JPMChase, which had a “tiered” charge for New York City customers, who would
pay $25 for the first five checks drawn on insufficient funds, while customers in other parts of the

Average NSF Fees in New York Regions: 2001-2004

31
Long Island
30 New York City

29 Western NY
Southern Tier
28 New York City Mid Hudson
Finger Lakes
Long Island Central NY
27
NSF Fee ($)

Finger Lakes Capital Region

Mohawk Valley
26
Mid Hudson North Country
25 Western NY
Central NY Mohawk Valley / Utica
24
Southern Tier

23 Capital Region

22
North Country
21
2001 Spring 2002 Fall 2002 Spring 2003 Fall 2003 Spring 2004 Fall 2004

state had a flat $30 NSF charge. The regional variation in fees may be explained by economic
differences across the regions. In 2002, the per capita personal income in the North Country
region was 61% below the state average, while the per capita personal income in New York City
was 8% above the state average.

Fees at Large Banks

Large banks in the survey tended to charge higher NSF fees than smaller banks. Two of the
largest banks in the survey, Charter One and Bank of New York, imposed the highest NSF fees,
$33 and $32 respectively.

When NSF fees charged by large banks are compared with those charged customers of smaller
banks between 2001 and 2004, large banks are seen to have consistently charged higher fees on
average. The NSF fee charged on average by banks with assets over $1 billion is close to 25%
higher than the average NSF fee charged banks with assets under $1 billion. In Fall 2004, 23 of
the survey banks had assets over $1 billion and 31 had assets less than $1 billion.

Average Fees at Large and Small Banks

2001 2004
Banks with assets over $1B $25.57 $28.79
Banks with assets less than $1B $20.06 $23.48

4
National Studies

Information on NSF fees is also available from national surveys by BankRate and the Federal
Reserve. All of the surveys showed similar increases in NSF fees. However, the results varied,
probably due to different composition of the groups surveyed.

The 2001 - 2003 averages from the New York survey are higher than those reported by Bankrate
in a national study. Bankrate’s survey of 490 accounts in the top 25 U.S. markets showed the
NSF fee climbing to an average of $25.80 in Fall 20034:

However, a study by the Federal Reserve in June 20035 found an average NSF fee in New York
State of $18.52 in 2001 and $20.62 in 2002, markedly lower than the national averages of $20.73
and $21.73, respectively. (About 620 institutions in the country were surveyed for this study.) New
York NSF fees may have been lower on average in these studies because of the NSF fee ceiling
that had been in effect for state-chartered institutions until 1999. The ceiling of $15 on the amount
that New York state-chartered banks could charge customers for bounced checks was lifted in
1999 to maintain competitive equity for state-chartered banks, by allowing them the same power
to set bounced-check fees that federally chartered banks operating in New York already had. The
average New York State fee was considerably below the nationwide fee from 1996 through 2002
in the federal study.

National and New York State NSF Fees: 1996 - 2002

24
22
NSF $ Value

20
18
16
14
12
10
1996 1997 1998 1999 2000 2001 2002
Year
NY Average Nationw ide Average

4
http://www.bankrate.com/brm/news/chk/chkstudy/20031031b2.asp
5
Board of Governors of the Federal Reserve System, “Annual Report to the Congress on Retail Fees and
Services of Depository Institutions,” June 2003.

5
Overdraft Protection

Many financial institutions offer their customers overdraft protection plans whereby they honor
checks written against insufficient funds for a fee. The terms and fees of these programs vary.

A typical overdraft protection plan allows a checking account to be linked to another deposit
(savings) account from which the insufficient funds are transferred for a fixed fee. This fee could
be charged per advance, per day of advance, sometimes in addition to an annual fee.

Bounce protection or “courtesy” protection plans, as they are sometimes referred to, activate a
loan to provide protection against insufficient funds or overdrafts. Banks impose a per item fee,
generally the bank’s standard NSF or overdraft fee which could be in the range of $20 to $35.
Some institutions also charge a fee, such as $2 - $5 per day on the outstanding balance.

There are also overdraft protection plans that consist of a link to a line of credit. The limit of the
credit is determined by the customer’s credit history and the interest rate on the outstanding
balance is around 18%. In addition, some institutions charge an annual fee and/or a fee per
advance.

Overdraft Fees Nationwide and in New York State

Information on overdraft fees is available both from a review of the overdraft fees charged by
banks with New York branches and from a study by the Federal Reserve. However, neither study
distinguishes among the types of overdraft programs.

According to the study by the Federal Reserve, overdraft protection fees grew steadily from
$15.67 to $21.80, or 39% from 1995 to 2002. This study found that overdraft fees in New York
trailed the national average between 1995 and 2002 – similar to the findings for NSF fees. New
York State has restricted the ability of state-chartered banks to offer certain types of overdraft
protection plans – in particular, “bounce protection” plans where banks honor checks written
against insufficient funds for a fee.

Overdraft Fee NYS vs. Nationwide

25
20
$

15
10
1995 1996 1997 1998 1999 2000 2001 2002

Nationwide NY Fee

Annual Report to the Congress on Retail Fees and Services of Depository

Institutions, Board of Governors of the Federal Reserve System, 1997-2003.

According to the Federal Reserve study, multi-state institutions charged 23% higher overdraft
protection fees on average than single-state banks; also, large banking institutions charged more
than medium-sized banks, while small banks’ fees were lowest.

In New York State the number of banks offering overdraft protection has grown over the last four
years. According to the Bankrate survey data, only a handful of small banks currently offer no
overdraft coverage.

6
To gain more information about overdraft programs, the Department informally canvassed
customer service representatives at the banks with branches in New York in the Bankrate survey
group. More than half of the survey banks (30 institutions) offer overdraft protection by means of
a line of credit linked to a checking account. Interest rates for these lines of credit range from
7.75%-18% annually, and limits on credit are between $500 and $25,000, depending on the
customer’s credit history. Fees per advance of $2 to $5 and $10-$25 annual fees are not unusual.
A third of the institutions surveyed offer bounce protection or courtesy payment plans, with an
average overdraft protection fee of $26. Sixteen of the survey banks offer a link between savings
and checking accounts as overdraft protection. The average fee per transfer from savings to
checking accounts is $10 for customers of these banks.

While some specialists suggest that fee-based overdraft programs are especially popular with
smaller community bankers, analysis of the Bankrate survey data did not show any greater
adoption of overdraft programs by small banks than by large ones. In fact, the two institutions that
did not offer overdraft plans in Fall 2004 were each small banks. Nonetheless, overdraft services
are viewed as a very effective method of generating profits, especially the programs that honor
checks drawn on insufficient funds for a fee rather than interest. These plans generally require
paying the balance within a short period of time, and consumer advocates argue that these plans
are disguised loans with astronomically high interest payments. Also, the more quickly the
customer brings the account back into balance the higher the effective APR will be6.

However, the biggest problem that consumer groups see is that many banks encourage
consumers to overdraw their accounts by promoting their overdraft plans as a reliable “safety
net.” There have been reports7 that some banking institutions include the bounce protection
amount in the reported balance, so a customer might be unaware that out of $600 shown as
available on his account, $500 is the bounce protection amount. A customer could incur an
overdraft fee without even realizing he had written a check against insufficient funds. Other
consumers may develop a habit of mismanaging their accounts and lose track of the checks
they’ve written8. Recently, federal bank9, thrift10, and credit union supervisors issued final
guidance on overdraft programs. The guidance covers safety and soundness considerations,
legal risks, and best practices.

Finally, the Department found that overdraft protection was not restricted to checking accounts in
New York; overdraft plans were available for ATM and debit card transactions as well as checks
drawn on insufficient funds at 16 banks in the survey. This finding points up the importance of
guarding against abuses in these plans. As more customers use ATMs and engage in point of
sale (POS) debit transactions, the availability of overdraft protection for electronic transactions
may become an important bank product. Based on data from 2003, the Board of Governors of the
Federal Reserve estimated that point-of-sale debit card transactions would increase more than
20% -- or to about 18.6 billion annually – in the U.S. in 2004. A study for the Federal Reserve
Bank of Atlanta estimated the total number of ATM withdrawals in the U.S. at 6.1 billion in 2001,
and observers reported the March 2004 monthly volume of ATM transactions at 919.2 million.11
(Annualized, this monthly volume is 10.8 billion.)

6
National Consumer Law Center, Consumer Federation of America, et al, Comments on Proposed
Amendments to Regulation DD and Proposed Overdraft Protection Guidance, August 6, 2004
7
ibid.
8
ibid.
9
“Joint Guidance on Overdraft Protection Programs,”
http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20050218/attachment.pdf
10
“OTS Announces Issuance of Final Guidance on Thrift Overdraft Protection Programs,”
http://www.ots.treas.gov/docs/4/480028.pdf
11
“ATM Monthly Transaction Volume Is Flat,” Amercian Banker – Bond Buyer, September 10, 2004.

7
Banks’ Revenue from Service Charges

Last year a representative of Celent Communications, a research and consulting firm focused on
information technology in financial services, said that the NSF fee has a profit margin in the 90%
range and accounts for almost two-thirds of banks’ income from consumer check fees.12 While it
is difficult to confirm this figure, regulatory report data do provide information about all service
charges for deposit accounts, including NSF fees. Call Report (FFIEC Reports of Condition and
Income) information for banks with branches in New York State showed both an increase in
revenue from these charges as well as an increase in the share of income represented by these
charges.

Unfortunately, overdraft or bounce protection fees are reported with interest income on loans on
the Call Report, so it is difficult to draw any conclusions about overdraft fees from Call Report
data.13 If banks reported income from overdraft fees, including bounce protection plans,
separately on the Call Report, then it would be easier to monitor the growth and prevalence of
these plans.

Commercial banks and trust companies are required to report quarterly revenue from service
charges on deposit accounts in domestic offices, including the fees charged depositors for
processing checks drawn against insufficient funds (NSF fees), on the Consolidated Report of
Income (FFIEC Schedule RI). Studying these service charges can indicate trends in NSF fees, as
they are a major component of this item. There were 185 commercial banks and trust companies
with branches in New York State as of 6/30/04, and Call Reports as of 6/30/01 are available for
175 of these 185 banks. The Department reviewed Income Statements and Balance Sheets from
the Call Reports of these banks to determine their revenue from service charges as of 6/30/01
and 6/30/04.14

On average15, across banks with branches in New York, the revenue reported in this item
increased by 59% between 6/30/01 and 6/30/04, while deposits grew on average by 58% over
the same period. However, smaller banks on average showed greater growth in service charge

12
Wade, Will, “Lockbox Conversion Trend Puts Savings Ahead of Fees,” The American Banker, March 20,
2003
13
In an article in The New York Times on January 22, 2003, Alex Berenson reported that according to the
FDIC “banks will charge $30 billion in A.T.M., bounced-check and overdraft fees this year.” Coincidentally,
the total across all U.S. banks of service charges on deposit accounts for 2002 was $30.7 billion, as
reported on the FDIC web page (www.fdic.gov). However, as pointed out in the footnote below, this item
does not include overdraft fees or ATM fees, and does include many other charges.
14
According to the instructions for Schedule RI, this item includes amounts charged depositors for:
• Maintenance charges
• failure to maintain minimum balances
• fees based on the number of checks drawn on deposits made in their accounts
• checks drawn on so-called “no minimum balance” deposit accounts;
• withdrawals from nontransaction deposit accounts
• the closing of savings accounts before a specified minimum period of time has elapsed
• inactive or dormant accounts
• NSF check charges
• issuing stop payment orders
• certifying checks
• the accumulation or disbursement of IRA or Keogh plan accounts when not handled by the trust
department of the bank
15
Four banks in the survey set were newly established as of 6/30/01. At 6/30/04, their revenue from service
charges had increased 16 times, 21 times, 47 times, and 124 times their 6/30/01 figures. These banks were
considered outliers and these increases were not included in the averages over the survey banks.

8
 Growth in Income from Service Charges on Deposit Accounts Compared with Growth in
Deposits, 6/30/01 to 6/30/04, at Banks with Branches in New York

80%

70%

60%

50%

40%

30%

20%

10%

0%
Average across All Banks Average for Banks with Average for Banks with
(175) Assets > $1 Billion (53) Assets < $1 Billion (122)

Average Revenue Increase from Service Charges Average Increase in Total Deposits

revenue than in deposits, while larger banks showed smaller increases in service charge revenue
compared to growth in deposits.
¾ Banks over $1 billion in assets showed revenue growth of 49% from service charges on
deposit accounts, while their growth in deposits was 70%.
¾ Banks under $1 billion in assets had growth of 64% in revenue from service charges but
only a 53% increase in deposits between 6/30/01 and 6/30/04.

There was significant variation in the rates of growth of service charge revenue among these
banks: the change in income from this item ranged between 100% and 500%.16

Revenue from service charges constituted a smaller part of total non-interest income for larger
banks than it did for smaller banks. However, these shares seemed stable; the respective shares
of non-interest income represented by revenue from service charges on deposit accounts
changed little between 6/30/01 and 6/30/04 for both large and small banks.

Importance of Service Charges to Income

Service charges on deposit accounts are an important source of non-interest income for banks
with branches in New York as well as across the nation. The 185 commercial banks with
branches in New York State reported a total of $5.9 billion in revenue from service charges on
deposit accounts at 6/30/04. These charges represented 17% of the total non-interest income of
$34.8 billion for these banks at 6/30/04. Total income from service charges on deposit accounts
was $16.2 billion for all commercial banks in the U.S. at 6/30/04, while total non-interest income
was $95.1 billion. Here again, service charges represented about 17% of total non-interest
income.

However, the service charge share of non-interest income at a particular bank is often much
higher, depending on a bank’s business profile. (JPMChase, Citibank, Bank of New York, and
GreenPoint all had service charge shares of non-interest income under 10%, while Bank of
America and Charter One had shares over 40%.) Also, smaller, less complex institutions may
have fewer sources of non-interest income than larger banks. For the banks with branches in
New York State, the minimum service charge share of non-interest income was less than 1% and
the maximum share was 100%. The average service charge share across all the commercial
banks with branches in New York was 41.8% as of 6/30/04. Banks with assets over $1 billion
showed an average service charge share of non-interest income of 26%; however, banks with

16
Ibid.

9
assets under $1 billion showed an average service charge share of non-interest income of 48.9%.
Thus, the large bank/small bank differences seemed to be present for service charges as well.
Service Charge Share of Noninterest Income, as of
6/30/01 and 6/30/04, at Banks with Branches in New York State

6/30/2001 6/30/2004

Average for Banks with 49%

Assets < $1 Billion (122) 48%

Average for Banks with 26%

Assets > $1 Billion (53) 27%

Average across All Banks 42%

(175) 42%

Charter

Patterns of revenue growth from service charges on deposit accounts were similar at state and
federally chartered banks with branches in New York State. There were 11317 state-chartered
commercial banks with branches in New York State, and 72 national banks as of 6/30/04. These
banks had a total of 4,837 branches in New York as of 6/30/04, with 62% of the deposits in 2,574
branches of state-chartered banks and the remaining 38% of deposits in 2,263 branches of
national banks. As can be seen from the table below, state-chartered commercial banks with
branches in New York showed on average a greater increase in revenue from service charges
than national banks. However, state-chartered institutions also showed greater growth in deposits
than national banks with New York branches. Service charges represented similar shares of non-
interest income at national and state chartered banks.

Service Charges at State and National Banks in NYS

State-Chartered Federally Chartered

Commercial Banks Commercial Banks
Number of banks with 113 72
branches in NYS
Growth in Service Charges 59% 43%
(6/30/01 – 6/30/04)
Growth in Deposits 62% 42%
(6/30/01 – 6/30/04)
Average: Service Charges as 44% 43%
% of Noninterest Income

Total Income

Higher service charge revenues seem to result in a greater percentage of total income from these
charges as well. Low interest rates over the 2001 – 2004 period may have contributed to a fall in

17
JPMChase and HSBC USA changed from state charter to national charter in late 2004. These banks
combined had 785 branches and accounted for 36% of deposits in New York State at 6/30/04. JPMChase
and HSBC USA are included with state-chartered institutions in these figures.

10
the share of total income represented by interest income when compared with the share
represented by non-interest income. As of 6/30/04, service charges on deposit accounts provided
a larger share of total income (interest plus non-interest income) for both large and smaller banks
than three years earlier. As of 6/30/01, the average share of total income represented by service
charges on deposit accounts was 3.6% across all the banks with branches in New York State; at
6/30/04, this share was 5.1% on average across all banks. This increase in importance of service
charges to total income was more pronounced at banks with less than $1 billion in assets than at
the larger banks. For smaller banks, service charges on deposit accounts represented 3.8% of
total income at 6/30/01 and 5.5% at 6/30/04, while these charges accounted for 3.1% of total
income at the larger banks at 6/30/01 and 4.2% of total income at 6/30/04.

It appears, therefore, that although smaller banks rely more than larger banks on service charges
on deposit accounts in their income make-up, they tend to charge significantly lower fees. The
2003 federal study18 also found that banks with offices in more than one state charged
significantly higher fees than banks that had offices in only one state. Twenty-one out-of-state
banks have branches in New York State, and 31 New York headquartered banks have branches
in other states. Since 37 of these 52 banks have assets greater than $1 billion, “multi-state” is
virtually equivalent to “large” in New York.

Check Volume and Electronic Retail Payments

Check 21 was enacted in an environment of continuing decrease in the number of checks written
by U.S. consumers. A recent study released by the Federal Reserve System19 estimated that the
number of checks written in the U.S. declined by an annual rate of 3.4% from 2000 to 2003. (An
earlier Federal Reserve Study estimated the annual decline in check volume from 1995 to 2000
at 3%.) In addition, the share of checks written by consumers -- as compared to checks written by
businesses -- seems to have fallen. Although the number of checks decreased, the average value
of checks paid in 2003 increased over the average value reported in 2000 from $950 to $1,070.
Since consumer checks tend to be lower in value than business checks, and since there is some
evidence that consumer checks have been more quickly converted to electronic payments, this
increase suggests a greater proportion of checks were written by businesses in 2003 than in
2000.

Also of interest in this study are the estimates of number of returned checks in 2003, as
compared to 2000, since returned checks incur NSF fees. According to the report, the estimated
number of checks returned declined 7.7% annually between 2000 and 2003, or faster than the
decline in the number of checks written. Approximately 189 million checks were returned in 2003,
down from approximately 240 million checks returned unpaid in 2000. The Federal Reserve
report’s authors suggest that this decline in checks returned unpaid may reflect better money
management by check writers, changes in banks’ practices for posting payments, or greater use
of overdraft programs. Interestingly, the estimated percentage of written checks returned unpaid
in 2003 (0.5%) was also less than the estimated percentage of checks returned in 2000 (0.6%),
and much lower than the estimate reported in 1995 (0.85%).20

18
Board of Governors of the Federal Reserve System, “Annual Report to the Congress on Retail Fees and
Services of Depository Institutions.” June 2003.
19
“The Depository Institutions Payments Study, Federal Reserve System, 2004.
20
Gerdes, Geoffrey R., Walton III, Jack K., “The Use of Check and Other Noncash Payment Instruments in
the United States,” Federal Reserve Bulletin, August 2002

11
A companion study of changes in electronic payments21 shows, not surprisingly, that the number
of electronic retail payments increased in all categories over the period 2000 to 2003. From 1995
to 2000 the number of debit card transactions grew from 1.4 billion to 8.3 billion annually,22 and in
2003 it almost doubled to 15.6 billion. Based on 2003 figures, the Federal Reserve estimated that
the number of debit transactions would increase 20%, to 18.6 billion, in 2004. Credit card
transactions went from 10.4 in 1995 to 15 billion transactions in 2000 and in 2003 this number
grew to 19 billion. Total electronic payments in 2003 were 44.5 billion, a 13.2% annual growth
from 2000 (see chart below), and, for the first time, accounted for more transactions than check
payments.

Changes in Retail Payments: 2000 and 2003

45

40 2000 2003

35
Number of Payments (Billions))

30

25

20

15

10

0
Credit Cards Debit Cards ACH EBT Total Electronic Checks
Payments

Although the study found a decrease in the percentage of checks returned unpaid, the
researchers also reported a relative decrease in the number of “on us” checks (or checks
deposited directly by the payee with the paying bank) compared to inter-bank checks (checks
deposited by the payee in a bank different from the paying bank). Since hold times are usually
longer for inter-bank checks, this suggests a greater impact of Check 21 than might be assumed
from the drop in check volume.

There is evidence, also, that electronic retail payment, particularly debit card usage, will continue
to increase. A study23 by the American Bankers Association in 2003 reported that use of debit
cards at the point of sale has grown from 21% in 1999 to 31% in 2003, while the use of cash at
the point of sale has fallen from 39% in 1999 to 32% in 2003, and checks were used for in-store
transactions only 15% of the time in 2003.24 Observers have also predicted that the use of
prepaid cards will grow in the next few years,25 while automatic payment and online bill payment

21
2004 Electronic Payments Study, for Retail Payments Office at the Federal Reserve Bank of
Atlanta, December 14, 2004
22
Gerdes, Geoffrey R., Walton III, Jack K., “The Use of Check and other Noncash Payment
Instruments in the United States,” Federal Reserve Bulletin, August 2002
23
2003 / 2004 Study of Consumer Payment Preferences
24
“Electronic payments trump paper,” ABA Banking Journal, February 2004, p. 17
25
“Paper or Plastic: New Card Options Promise to Further Displace Checks,” Item Processing Report, Vol.
15, No. 15, July 29, 2004

12
were used by 60% and 41%, respectively, of consumers in 2003.26 The authors of the Federal
Reserve depository institution payments study27 estimate the number of ATM withdrawals in 2003
at 6.1 billion. Interestingly, point of sale ATM fees have also risen in New York State from an
average of $0.52 in 2001 to $0.72 to 2004, according to the New York State survey data.

Some observers have estimated that cutting out a half-day from the float period – as Check 21
has been predicted to do -- could drive the number of bounced checks up by 7 million additional
checks per month, and that fees on those additional bounced checks could generate almost $170
million a month for banks.28 It is hard to substantiate such estimates. Also, given the change in
consumer payment preferences, the increase in banking revenue from NSF fees as a result of
Check 21 may be smaller than the increased revenue from overdraft programs for combined
check, debit, and ATM transactions.

Check Imaging at New York State Banks

Check 21 reduces the circulation of paper checks in the check clearing process. Instead, banks
produce and process a new negotiable instrument that represents an electronic image of the
actual check. Customers can see the image of their written check online or receive a substitute
check that banks can print and send out with the statement or upon request.

Many banks have been using check images for years. In an informal survey conducted before
Check 21 went into effect, the Department found that 44 of the 53 survey banks offer check
imaging, and two more planned to provide check imaging by January 2005. More than three
quarters of these institutions provide this service for free. The check-imaging fee in the other
institutions averages $3.25 per month and is at most $6. Twenty-seven of the banks that offer
check imaging do not return the actual cancelled checks, while three institutions will provide the
customer with either the actual check or the check image upon request, depending on the
availability of the cancelled checks.

Approximately half of the banks (26 out of the 53 in the survey) still returned cancelled paper
checks in October 2004. Half of them provided this service for free; others charged a fee ranging
from $1 up to $5, with a charge of $3 the most frequent.

Survey banks have instituted programs to encourage their customers to use electronic check
images rather than the original checks for record keeping. Some institutions waive checking
account service fees if checks are not returned with the monthly statements. Others can reduce
fees by 9%– 63%. The number of banks in the survey that offered a 40% - 60% reduction in
account service fees to customers that accepted electronic check images increased by more than
a third between 2001 and 2004, while those that reduced fees by 20% - 30% doubled over the
same period.

Banks’ Plans for Implementing Check 21

The Bank Administration Institute (BAI) conducted a web-based survey of 170 financial services
managers on their institutions’ Check 21 readiness in early October of 2004.29 Over 90% of the
respondents said that their institutions would be able to meet the minimum requirements of the
Act – receive and process substitute checks, make consumers aware of the law and their rights
under it, and provide expedited re-credit as required by Check 21 -- when it was implemented.
Interestingly, opinion ran three to one among the participants that financial institutions would
make deposits available more quickly as a result of the Act, and six to one that they would make

26
“Electronic payments trump paper,” ABA Banking Journal, February 2004, p. 17
27
“The Depository Institutions Payments Study” Federal Reserve System, 2004.
28
Wade, Will, “Early Notes: Updating Consumers on Check 21,” The American Banker, August 10, 2004
29
http://www.bai.org/check21/surveyresults/index.asp

13
funds available to commercial customers more quickly. Two-thirds of the respondents said that
their institutions would begin exchanging check images within a year, while under 4% said that
they had no plans to exchange check images.

Among the institutions surveyed by the Banking Department, about one third of the 51 with
websites had a notice about Check 21 on their websites. Many of the others planned to send
brochures to their customers.

Conclusions

Fees for checks drawn on non-sufficient funds as well as fees for overdraft and bounce protection
plans have risen at banks surveyed for the New York State Banking Department. These banks all
have branches in New York State, and together hold 84% of the deposits in New York State bank
branches. This increase in fees is of particular interest since the Check Clearing Act for the 21st
Century was recently enacted. Check 21 came into effect against a backdrop of falling check
usage, rising electronic payments, and increased reliance by banks on fees, including service
charges on deposit accounts. Consumer groups have predicted an upsurge in bounced checks –
and bank revenues from NSF fees – as a result of Check 21. Trends in retail payments may
make any surge in NSF revenue temporary. However, overdraft and bounce protection fees,
which may be offered for debit and ATM transactions as well as checks drawn against insufficient
funds, may have a greater impact on consumers. However, without a requirement that banks
report income from overdraft fees separately on their regulatory reports, it is difficult to monitor
the growth and prevalence of these plans.

14