These weekly pieces are written by a very influencial "Banker with a Conscience," and submitted to my Blog as Guest Op-Eds. Gets you into the mind of someone at the very top of the financial services sector; how they see the current global economic crisis (the mess), as well as various government and private sector solutions to get us out of it.  Hope you enjoy reading them.   

In past columns we have spent a lot of time on mortgages.  Let’s leave that behind for a while and talk about basic banking services for Americans.  In all the rhetoric and politics surrounding the Dodd-Frank Bill and the Durbin Amendment, not to mention last year’s implementation of a revised Federal Reserve Reg E (covering overdraft and NSF charges) a lot of discussion has taken place about what might happen to basic banking services.

As a novel way to start the discussion, let’s get some facts on the table.  There are two sources of profit on checking accounts— (1) fee income generated on the accounts and (2) interest or spread earned on the balances deposited.  Basically, to earn a spread the bank loans out the deposited funds and makes the difference between what the bank pays in interest on deposits and what it collects on loans.   There is, course, considerable cost in servicing checking accounts—branches, tellers, ATMs, telephone and computer banking, etc. etc.  Noteworthy is that almost all those costs services represent costs for which there is no explicit price or fee. 

Historically, the spreads plus the fees allowed banks to make a decent profit without having to charge monthly fees or to have explicit charges for the services offered with checking accounts.  But turn the clock back to the post-war period and up through the 1980s and you would see that most accounts paid a monthly fee.  $6 to $10 a month was pretty common across the industry during those decades. 

A couple of things happened along the way.  The “back room” cost of checking went down as the cost of computers, mass storage, etc. went down.  Banks became better managed and the economy allowed spreads to open up.  It wasn’t uncommon to see banks with NIM (net interest margin) of 5 or 6%.  Some operational changes like imaging checks and computer statements further lowered costs.   This ultimately led to banks starting to lower and even eliminate the monthly fee on checking.  “Free Checking” became the standard consumer product and banks did just fine because of the lower costs, healthy spreads and fees.

After a decade of free checking (meaning the 1990s) the pressure on profits started to mount.  A mild recession, increased competition from record numbers of new banks, fast growing credit unions (that paid no income tax), irrational competitors like CountryWide and WAMU, internet firms like ING, and money market funds, all took the bloom off the checking account rose.  The basic calculus at most banks was pretty simple—we can’t increase spread because of fierce competition, we can’t eliminate free checking because of fierce competition, so we better look at raising the other fees.  Each individual decision made sense—increase the overdraft fee, increase the maximum number of overdraft fees in a single day, increase the ATM fee for non-clients using the ATMs, increase the ATM fee for your clients using someone else’s ATM, allow people to overdraft their account at the ATM—but the net of all those decisions ended up being a problem.

What was the problem?  The problem was that two segments of clients were really subsidizing “free” checking for every one else.  The two segments were nearly polar opposites from a demographic perspective.  One segment was the very high balance clients.   Those that left very large balances in their checking accounts were very, very profitable because of the spreads the bank could make on the balances.  The other segment was the “frequent overdrafters”.  The fees earned on this segment helped subsidize all the low balance clients that were very unprofitable because they neither provided balances the bank could invest, nor did they incur any fees despite their use of the tellers, telephones, bill pay and other free services.

Clearly the price increase reached the tipping point and Reg E was changed to give clients a clearer picture of these overdraft charges and it also required the banks to give people an explicit choice to “opt out”.  The bottom line is that banks lost anywhere from 40 to 70% of their checking account fee income, right at the very moment that historically low rates in the economy dramatically reduced spreads on the checking balances.  At this point (summer of 2010) banks began laying their plans to both increase fee income from sources other than OD fees and to lower costs of supporting the checking product.

All this, of course, before the anticipated effective date of the Durbin Amendment which slashed the interchange banks were making off the fees charged merchants when a client used their debit card (more on this next week).  If Durbin were to go forward as presently proposed by the Fed, banks would lose another huge slug of fee income directly related to the checking account product.

So, where does this all lead.  Almost certainly it leads to the elimination of unrestricted free checking.  To get free checking in the future, clients are going to have to carry larger balances, buy more of their banking products from a single bank to raise their overall attractiveness to the bank, get fewer free services, and pay more for ‘a la carte’ services.  They might even find their bank closing some branches to reduce costs. 

The end result is probably a more “fair” system in the sense that no one is subsidizing someone else’s free checking.  But, it will certainly be a strain on the responsible low income families that didn’t overdraft, but had a very low balance account and enjoyed the services they used for free.

What can the low and moderate income family do?  In most cases if they arrange direct deposit of their pay check, open a savings account, and move their credit card account to their checking bank, that will almost for sure get them a free account with all the bells and whistles going forward.  Toss in the car loan or mortgage and they will have banks clamoring for their business.  It is likely that seniors, military and students will still be able to command a free account, but it will probably have limitations like computer statements only, no reimbursement for use of other banks ATMs and no more free checks.

Rewards for using debit cards are fast going the way of the dinosaurs (extinct) and it isn’t out of the question that debit cards will change dramatically if the Durbin Amendment is allowed to go into force at the current rates proposed by the Fed.  

We will examine this topic more in coming columns as we seek to figure out how to maintain access to the banking system at prices low and moderate income families can afford.


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