Banking Strategies featured an article recently describing how banks need to move away from fixed overdraft limits and develop a more nuanced approach. Many are still using the same overdraft limit for all customers. As a result, the limit is too high for some customers making them more likely to default while the limit is too low to properly serve other customers.
Smart credit card providers have become adept at finding the right limit for each type of customer. They test different limits with thousands of prospective customers and compare against random control offers. By measuring the impact of different limits and segmenting the result by criteria like credit scores, they can determine the right limit for each type of customer to maximize revenue and minimize default.
Finding the right overdraft limit is a tougher problem. Banks do not have the luxury of sending offers to tens of thousands of random prospects, and there is risk of losing customers by not getting the limit right. Banks also have a wealth of information about each customer, and it is challenging to know what is important in setting overdraft limits. Is prior balance fluctuation the most important indicator or do factors like tenure or demographics matter more?
To find the optimal dynamic overdraft strategy, banks need to find a way to try different approaches with a limited number of customers. It will be important to both measure the impact of each strategy and to also identify which factors matter most in setting the overdraft limit for a customer. With overdraft revenue squeezed by regulation, banks need to be innovative and rigorous in their approach to maximize revenue and minimize default.