Deposit Fees: Here Comes the Judge

This week, a US District Judge issued a snarky rebuke of the Federal Reserve's 24 cents per debit card transaction cap, sometimes known in the common sense world as price fixing. Judge Richard Leon opined that a seven to twelve cent cap would be more in line with Dodd-Frank's Durbin Amendment. 

How do I feel about the Durbin Amendment in general and how it likely came about can be discerned from a previous post. But fundamental to the Amendment, and Judge Leon's ruling, is a misunderstanding of how banks make money.

Checking accounts are not cheap to originate and maintain. Banks expend a tremendous amount of energy wrestling what they perceive as profitable customers from other financial institutions. Additionally, once they find a willing customer, they must comply with a myriad of laws and regulations to prevent fraud, money laundering, fairness (whatever that means), or any other potential financial crime our government deems worthy of bank policing.

According to my firm's profitability peer group database, it costs financial institutions, on average, $420 annually to originate and maintain a retail, non-interest bearing checking account. How do banks cover this cost?

Fees. And Spread.

Deposit fees have been on the decline for some time now (see chart). Part is because of changes to regulation, including Dodd-Frank and the dreaded Durbin Amendment. But some is also customer behavior modification. Although the overwhelming customer response to automatic overdraft coverage was positive (customers preferred their checks to be covered rather than bounced), the fees served the additional purpose of changing customer behavior.

It should be noted that the 13 basis point decline in deposit fees equates to $2.2 million in annual revenue to the average financial institution ($1.7 billion in deposits, on average). How does a bank make that up? If they did it on personnel cuts, the average bank would have to reduce staff by 44 employees. But reality lies somewhere in a combination of cost savings, revenue enhancements, and reduced profits.

Back to the checking account and its $420 annual cost. According to my firm's peer database, each retail DDA account averages $25 in fees per year. That means the checking account must generate $395 in spread to break even. Pick a spread number... say 3%? The checking account would have to carry an average balance of $13,167 to cover its costs. That's to break even!

My point to Messrs. Chris Dodd, Barney Frank, Dick Durbin,and Richard Leon is you don't know squat about how businesses make money. Why don't you analyze a McDonald's value meal, where all the margin is made on the Coke. Price fix the Coke, and the price of the burger or fries will go up. So be it in the checking account. Think about that the next time in the drive thru buddy.

Any thoughts on Judge Leon's genius comment that the fixed price on a debit interchange fee should be seven to twelve cents?

~ Jeff

Ficticious Interview: Senator Chis Dodd and Rep. Barney Frank

Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA) were primary sponsors for the Dodd-Frank Wall Street Reform and Consumer Protection Act which was signed by President Obama on July 21, 2010. Rather than arrange for an actual interview with the lawmakers so they can give me non-answer answers, I envisioned how an interview with the esteemed gentleman might transpire. Here is how it played in my head:

jeff-for-banks (jfb): What is your definition of a "financial crisis"?

Dodd: When Joe the Plumber can't get a loan to buy a multi-million dollar home on Florida's Gold Coast. That's not just a crisis, it's tragic.

Frank: When Fannie and Freddie stop contributing to my PAC.

jfb: How did the Government Sponsored Entities, such as Fannie Mae, contribute to the financial crisis?

Frank: I don't think Fannie and Freddie are financially insolvent. I don't believe they require large bailouts (Note: Actual July 2008 quote by the gentleman from Massachusetts. See video below).

Dodd: Barney just told you they stopped contributing.

jfb: Should individuals be accountable for taking loans they could not afford to repay?

Frank: The necessary evil of capitalism is that there are evil forces intent on perpetrating ill-will on the working class and it is the responsibility of everyone to enlist government officials to stand guard against bad players regardless of the cost and reliance on government because we are here for you, the working class, not the rich.

jfb: Huh??? Senator Dodd, same question.

Dodd: Personal responsibility is so 1950's. It took the 60's enlightenment to end such a fascist concept.

jfb: I read that the Bureau of Consumer Financial Protection will have a $500 million annual budget. Is this accurate?

Frank: I hope not. Creating this bureau was a key provision in Dodd-Frank and a budget that doesn't end in a "B", or better yet, a "T", doesn't demonstrate our commitment to creating a black-hole bureaucracy.

Dodd: No worries. We'll charge it!

jfb: The Durbin Amendment requires the Fed to determine the "reasonable and proportionate" interchange fee that can be charged on debit and credit card transactions. Historically, when has price fixing worked?

Dodd: Nixon did it in the 70's with gas prices.

Frank: (laughs) Son, I understand you're a coal cracker from Scranton, had a hard-scrabble life, and may not understand these things. The Durbin Amendment is not price fixing. The Fed is only going to set the reasonable fee that can be charged.

jfb: How do you envision the Fed determining which systemically risky firms to unwind during a future financial crisis?

Dodd: Although the law is 5,000 pages, we left it up to the Fed to determine how to do that. I'm sure they'll do a good job.

Frank: I envision a panel like on the reality TV show America's Got Talent. Bankers like Jamie Dimon can make their case to Piers, Sharon, and Howie who can buzz him if they don't like his shtick.

Dodd: (laughing) Barney's kidding.

Frank: No I'm not. I love that show. Great concept.

jfb: Will Dodd-Frank solve the problems that created the financial crisis?

Frank: We are creating a financial system with greater government control and a new bureaucracy with a $500MM plus budget with significant powers. What could go wrong?

Dodd: What do I care? I'm outta here!

jfb: Thank you for your time gentleman.

Reminder in case you are an angry politico... the above was a figment of my imagination. Any complaints can be lodged to some government agency with a big budget that was designed so you can cry on their shoulder.

- Jeff