The Department of Education on Tuesday finalized a set of rules that will restrict certain banking practices for federal student loan servicers.

The restrictions, first proposed by the agency in May, create new standards for universities and lenders that partner with them. The rule bans ATM surcharges, overdraft and point-of-sale fees for students serviced by a financial institution on behalf of their school. Instead of nudging students towards a preferred institution, schools will have to present a "neutral" set of banking options to students, including preexisting accounts. Moreover, universities and colleges will have to ensure students banking independently from a school-sponsored institution will receive their funds in good time.

Consumer advocates hailed the new restrictions on fees targeting students, sometimes through college-issued debit and prepaid cards that double as student IDs. A 2012 U.S. Public Interest Research Group found that about nine million, or 42% of all higher education students, were enrolled at schools that issued sponsored cards for the delivery of federal loans funds.

"The previous business model appeared to be built on the back of a bank charging big fees to students," said Maura Dundon, a senior policy counsel at the Center for Responsible Lending. The rules will protect students, she said, and ensure "they're going to be able to get their aid money."

The regulations have been a long time coming. In March, the White House directed federal agencies to protect student borrowers in what it called a "Student Aid Bill of Rights." And in a September report, the Consumer Financial Protection Bureau called out a system riddled with "widespread servicing failures," including surprise fees, opaque lending practices and unexpected default actions.

Individual politicians have also sounded out on these banking practices, including Sen. Sherrod Brown, D-Ohio, the ranking member of the Banking Committee. "These common-sense reforms will help protect students from hidden and excessive fees, secret contracts between schools and financial institutions, and other harmful practices that drain federal financial aid and make college even more expensive," he said in a statement Tuesday.

But banking groups, including the Consumer Bankers Association, the Network Branded Prepaid Card Association and the American Bankers Association, deplored the measures in what they saw as regulatory overreach.

"The Department of Education trying to regulate in the finance services space is going to add compliance costs, it's going to add compliance risks," said David Pommerehn, the senior counsel at CBA. He suggested, for instance, that schools forgoing third party-issued debit or prepaid cards would have to now shoulder additional processing costs.

"One bad actor in the market" had unfairly tainted the reputation of other servicers in the eyes of consumer groups, he added.

One card company dominates the student lending field: According to a Feb. 2014 report from the U.S. Government Accountability Office, 57% of all ATM cards issued by colleges and universities were provided by Higher One. The New Haven, Conn.-based company has been accused of predatory banking practices for years; in 2012, it agreed to pay $11 million to the Federal Deposit Insurance Corp. for trade violations, including hobbling accounts with nonsufficient-fund fees.

Pommerehn also said the restrictions could result in a dearth of banking options, particularly for students in rural areas.

Consumer advocates counter that the regulations would encourage competition, with colleges restrained from directing students towards one privileged account holder.

"The Education Department has struck a balancing act here," said Rohit Chopra, a senior fellow at the Center for American Progress and former CFPB official who noted that the rules lay out two types of arrangements between schools and financial service providers.

Under a less restricted "tier 2" situation where students bank directly with a third-party financial institution, and not through the school, the overdraft and point-of-sales fee ban does not apply. "I think that this is definitely going to expand choices for students," said Chopra.

The Department of Education also released final rules expanding the number of borrowers eligible for the Pay as You Earn student loan repayment plan, which caps monthly payments at 10% of annual income, by 5 million.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.