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

Bank Fees: Are We Out to Get-em?!

Banking has taken a beating in the media and court of public opinion in the past two years. Some of it has been unfair, particularly with how banks were associated with subprime mortgages (very few were originated by banks) and how community banks were lumped in with the practices of very large financial institutions (FIs). But if we are to be honest with ourselves, some of it is deserved and we should take positive steps to repair our image, better serve our customers, and lead us into the future.

I would like to look at three issues regarding our profession:

1. Executive Compensation;

2. Fees; and

3. Product Pushing

I focused on Executive Compensation in my last post, and would like to focus on fees here.

Fees are an absolute necessity to developing profitable products. For example, it costs a financial institution (FI) on average $388 per year in operating expenses to originate and maintain a non-interest bearing checking account (see chart).

According to my company's profitability database, FIs collect $24 in fee income per checking account per year, on average. That leaves $364 to be made up in the spread. As my banker friends know, re-investment rates are at all time lows. If an FI can re-invest checking balances at a market rate of 2.43%, as was the case in the second quarter of this year, a checking account would have to carry an average balance of $15,000, just to break even!

For the non-banker reading this post, if there are any, this may be an epiphany to you. Checking accounts are not inexpensive to maintain. Since re-investment rates that drive the spread are largely out of an FIs control, we turn to fees. This makes perfect sense.

But fees are under attack, as the link to a recent Wall Street Journal article indicates. It is part of conventional wisdom that all fees charged by FIs are bad, and forced on the public by insidious bankers. How did this perception come about?

Probably as a result of the logic presented above. In order to make deposit products profitable, fee income is an important part of the revenue stream. But this drive to increase fees came at the expense of reputation risk. I'm talking about the decisions bankers may have made with little discussion about how the application of this fee or that will be perceived by the FIs customers and the public at large.

An example of fee income gone wild is the order of check presentment to maximize overdrafts. You know what I'm talking about... ordering the checks received during a business day so that the large ones are presented first, causing an overdraft, and the subsequent checks are all overdrawn as well. If we presented them in a different order, the FI may have honored most of the checks. This may have sounded like a good idea when the vendor presented it to us, but the accumulation of decisions like this has led the public to draw its conclusions that we are "out to get them". We must consider this possibility in future decision making.

Recent legislation and regulation has put pressure on fees. The opt-in requirement that has the potential to reduce overall deposit fees has not resulted in wide-scale deposit fee declines (see chart). But the Durbin Amendment to the Dodd-Frank Act was worrisome, and now that the Fed has proposed reducing interchange fees from an average of $0.44 per debit transaction to $0.12, we will seek new revenue sources and expense reductions to offset the loss.

But while looking, we must ask ourselves the following questions:

1. Are we providing value that the customer should be willing to pay us for?

2. Is this fair to both our FI and the customer? and

3. Are we delivering the product and service as efficiently as possible?

I think if the answer is yes to all three, then customers should be willing to incur changes to their deposit products that allows their FI to profit fairly from their business.

If we answer no to any one of the three, then we will be encouraged to try old tricks... charge fees with as little transparency as absolutely required, and run the reputation risk we have so willingly accepted up to this point.

~ Jeff

WSJ Article: Why Checking Fees Keep Going Up
http://online.wsj.com/article/SB10001424052748703865004575648603199758586.html