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Fed asserts protective role in banning fees on overdrafts

Flexing newfound muscle as consumer protector, the Federal Reserve on Thursday banned overdraft fees on automated teller machine and debit-card transactions unless consumers have actively opted for an overdraft protection service.

The new rules mean that banks will be required to get their customers’ permission before charging fees when debit-card and ATM transactions trigger an overdraft. Customers who don’t elect to have overdraft coverage will see their charges rejected if they put their bank accounts into the red.

Consumer advocates lauded the move as long overdue but said stronger measures contained in pending legislation introduced by Democrats were needed as well.

The Fed’s rule, which takes effect July 1, does not cover fees for overdrawn checks or overdraft charges from recurring debit transactions, such as automatic payments for bills. The proposed laws would cover those transactions as well.

“The Fed should be applauded,” said Lauren Bowne, staff attorney for Consumers Union, which had argued that the overdraft charges were really a form of high-interest loans. “Soon, banks will have to persuade their customers that these overdraft programs are beneficial compared to other lower-cost alternatives.”

But other research and consumer groups were disappointed.

“We appreciate that the Fed chose to implement the strongest overdraft reform rule it was considering,” said Eric Halperin, head of the Center for Responsible Lending’s Washington office. “But this improvement is undermined by the Fed’s failure to propose or enact necessary safeguards against a host of unfair practices.”

Over the protests of consumer groups, service charges on bank-deposit accounts have been an increasing profit center for banks in recent years, totaling about $182 billion in the five years through 2008, according to the Federal Deposit Insurance Corp.

In the first six months this year, such fees raked in $21.5 billion, nearly as much as the $22.1 billion total for all of 1999, the FDIC tally shows.

Under former Chairman Alan Greenspan, the Federal Reserve had maintained a hands-off attitude toward regulations designed to protect consumers, with Greenspan arguing that free-market competition would work to benefit the public.

But current Fed Chairman Ben Bernanke has adopted a more consumer-friendly stance following the Fed’s failure to rein in mortgage lending, which is widely blamed for helping to create the global financial crisis, and the response in Congress, where some legislative proposals challenge the central bank’s authority.

The Fed’s move toward consumer protection comes as the Obama administration is trying to strip the agency and three other bank regulators of such powers and place them with a new Consumer Financial Protection Agency.

The Fed’s mission, originally defined as promoting full employment and maintaining price stability, was expanded to consumer protection in the 1960s when Congress tapped it to oversee enforcement of the landmark Truth in Lending Act.

The central bank was further given the authority to write rules governing home lending in 1994 but never did so until last year, after the collapse of the mortgage and housing markets had occurred.

“Their failure to act to rein in mortgage lending ultimately triggered the collapse of the economy,” said Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group.

Senate Banking Committee Chairman Christopher J. Dodd, D-Conn., has introduced legislation limiting bank overdraft fees, and Rep. Carolyn Maloney, D-N.Y., has introduced a similar bill in the House.

Advocacy groups say consumers would rather have a debit-card transaction denied than pay substantial overdraft fees.

According to the Center for Responsible Lending, the average shortfall is $17 for an overdraft triggered by a debit-card transaction – and the fees for covering the transaction can cost twice as much.

The group also contends that most banks manipulate their debit-clearing systems so that high-dollar transactions are debited first each day, which also can drive up fees.