Class Actions and the Economics of Internal Dispute Resolution and Financial Fee Forgiveness

This report shows that the Consumer Financial Protection Bureau’s proposed ban on arbitration contracts that foreclose class-action litigation remedies is likely to reduce consumer welfare. The paradigm case that the agency advances to show the utility of class-action litigation—the Gutierrez v. Wells decision and the subsequent overdraft settlements—is founded on an economic fiction. When banks look to customer profitability to assess fee forgiveness, they are expanding the range of financial options for consumers who may prefer to maintain low balances or frequently overdraft—perhaps because of their own financial constraints. Banks will not offer credit and financial products and services to consumers unless they can expect to make a profit on the accounts.

As this report shows, the market sanction of losing business, not potential liability, is what creates the incentive for a bank to forgive customer fees. Arbitration—which is intended to be a cheap and highly accurate forum for determining if a fee was wrongly assessed—is a supplement to market incentives. But arbitration cases are, and should be, rare.

Class-action liability, in contrast, cuts the return to a bank from investing in costly but informative ex post dispute-resolution systems and creates further ex ante risk from dealing with low-balance, high-transaction-volume customers. On the margin, at least some banks are likely to abandon their costly fee-forgiveness programs and ration customers up front by charging higher fixe d fees or balance requirements. In this way, the real losers from the CFPB’s insistence on requiring class-action liability for bank fees are the vast majority of class members who never receive compensation under a class-action settlement but face higher up-front fees and balance requirements for banking. In many cases, such fees and requirements are likely to be so high that many lower-balance consumers end up with no bank at all.

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