Solution in my case was to change length of the password in /override/classes/Customer.php to the value 60 (password data type in database is varchar(60)).
Specifically this line:
'passwd' => array('type' => self::TYPE_STRING, 'validate' => 'isPasswd', 'required' => true, 'size' => 32),
to
'passwd' => array('type' => self::TYPE_STRING, 'validate' => 'isPasswd', 'required' => true, 'size' => 60),