Nothing for Something?

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empty-tray.jpgEvery consumer is intrigued by the offer of something for nothing. Retailers have depended on the positive, natural response of consumers to this marketing message for decades to generate purchasing interest.

So it is odd, strange and frankly confusing that mega banks (Bank of America, JPMorgan Chase and Wells Fargo), which claim to be retailers, are doing just the opposite by offering “nothing for something” when it comes to charging their customers for debit cards.

Sure, debit cards have inherent value. But financial institutions of all sizes have diluted that value by giving the cards away for many years. This has trained consumers to feel that banks can make money by providing them for free and are now being greedy by charging for them.

Three, four or five dollars per month for a debit card probably won’t put many more people in the poor house, but it sure feels unfair. Response has been overwhelmingly negative by customers, non-customers, consumer advovcates, politicians and even other financial institutions.

As a practicing amateur psychologist, it is easy to see why the reaction has been so negative. Nobody: rich/poor, male/female, black/white/brown, gay/straight, or city slicker/hayseed likes to get nothing for paying something. It violates what economists call the “fair exchange of value.” It violates what I call common sense.

And that’s what these big banks miscalculated here. It’s not the amount of the fee itself that is riling up the masses, nor is it the justification of why fees must be charged:—the government made us do it.

Rather, it’s the perception of the fee as unfair that’s causing the uproar. Earlier this year, Russell Herder, a Minnesota-based marketing research company, conducted a survey of more than 500 United States bank and credit union checking and savings account customers to ascertain if, and to what degree, loyalty to their financial institution is impacted by fees.

The bottom line, according to the survey: “The belief that a particular bank fee is unfair has a much stronger impact on consumer sentiment than the fee itself. In fact, as long as charges are perceived to be fairly assessed, the research showed no negative impact on consumer sentiment whatsoever.”

If you don’t believe these results, tell me how you feel about having to pay for your luggage when you fly.

It’s this miscalculation of the impact of these fees on the collective psyche that provides a fantastic opportunity for competing financial institutions. It offers a “bags fly free” type of marketing opportunity to gain market share and mind share of consumers just like Southwest Airlines has.

There are smarter ways to get more fee income from consumer checking customers than, in their minds, getting charged something and getting nothing. You have to be creative and not rely solely on traditional checking design and pricing, because these also face customer backlash given the value perception in customers’ minds anchored around “getting charged for using my money”.

But it can be done. Hundreds of banks are successfully doing this already and there are millions of checking customers gladly paying fees equal to or greater than what these big banks are requiring customers to pay for debit cards. Customers are willingly paying $5-$7 per month for benefits like local merchant discounts, identity theft protection and accidental death insurance (bundled with traditional checking benefits). These benefits provide tangible value to customers in terms of real savings and ample personal security. In other words, banks are simply asking customers to pay a modest fee for something that is perceived as and is valuable, instead of for paying something and getting nothing new for it in return.

Someone said “chaos creates opportunity”. And when it comes to consumer checking accounts, this is just the beginning of chaos that we’ll see as banks try to recapture lost fee income. For some of you reading this, it’ll be your “bags fly free” opportunity. For others that follow the lead of Bank of America, it’ll be just another reason for consumers to broadly brush banks as out of touch with their customers.

Which one are you? 

What’s Next for Consumer Checking after Durbin?

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checking.jpgThe two major checking-related fee income sources have been the targets of regulation. Durbin will decrease interchange fees by about 45 percent (44 cents per average transaction down to 24 cents). Sure, there’s still uncertainty regarding the exclusion for financial institutions with less than $10 billion in assets, but even the most optimistic banker will concede that interchange fees will not be at levels where they’ve been before. Add to that, the estimated financial impact of FDIC and OCC overdraft guidance – a reduction of an additional 15 percent to 25 percent on top of Reg E’s first year negative impact of about 10 percent to 20 percent. So, checking account products and pricing will have to change to adapt to these new rules.

These changes to replace lost fees won’t be popular, given overall consumer sentiment towards banks these days. This challenge is compounded by the fact that free checking has convinced consumers that traditional checking benefits aren’t worth paying for. In the minds of many consumers, since banks have been able to financially justify not charging for these benefits for the last decade or so, no longer doing so is just another “fee grab” by greedy banks.

This means the easy and convenient changes like starting to charge fees for the same benefits that have been free or instituting certain requirements, like minimum balances to avoid penalty fees, is a risky move. It will anger customers, especially the most profitable ones, and chase many of them away to competitors. Plus, history has proven that these kinds of checking changes will generate only a fraction of the revenue that needs to be replaced.

Banks must make changes to their retail checking accounts to incorporate a fair exchange of value with customers. This means an upgrade in what they get when their bank begins charging fees for services. Sorry to sound like a broken record, but charging fees for benefits that customers haven’t paid for in the last decade or adding requirements to avoid a fee is a tough sell, and just defaulting to this approach will be unproductive at best.

So smart banks see the post-Durbin world of checking as an opportunity to launch innovative checking products-including adding non-traditional checking benefits deemed worthy of a charge, such as local merchant discounts and identity theft protection. And look for pricing strategies that simply and immediately reward customers by reducing checking fees based on desired banking behaviors from customers that don’t revolve around minimum balances. This differently defined “pathway to free” will replace the traditional free checking account, which will be hard to justify in the future from a profitability standpoint.

Who Gains the Most From Final Interchange Rule

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The Federal Reserve’s final rule released this week on the debit interchange or “swipe” fees that retailers must pay looks like a clear victory for the banking industry, as it will allow banks to charge double what had been previously proposed.

For some, it’s more of a victory than for others. Banks that have relied heavily on debit fee income to support their business models, such as TCF Financial Corp. in Minnesota, clearly have more to gain by the change from the proposed rule. The final rule allows banks to charge about 24 cents per transaction, up from about 12 cents under an earlier proposal (both of which include a surcharge for fraud protection).

Banks, thrifts and credit unions with less than $10 billion in assets are supposed to be exempt from the new rule, but it remains unclear whether the marketplace (i.e. Visa and MasterCard) will create a two-tiered system that protects the smaller banks.

An analysis by the research and investment banking firm Keefe, Bruyette & Woods (KBW) this week says TCF Financial Corp. had the most to gain from the change in the proposed rule. If you’ll remember, TCF is the bank holding company that sued the federal government last October over the constitutionality of the interchange rule, otherwise known as the Durbin amendment to the Dodd-Frank Act.

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TCF’s stock shot up 4.8 percent from Wednesday morning to early Friday afternoon on the New York Stock Exchange, to $14.40 per share.

KBW’s analysis shows that TCF, which has $18.7 billion in assets, will make 11 cents more per share  in 2012 earnings with the change just made to the final rule, all else being equal. That basically means TCF will see its earnings cut 22 cents per share in 2012 instead of 33 cents, as previously proposed. The analysis doesn’t take into account any possible changes to fees, such as an annual debit fee for consumers, that banks may implement to make up for the loss in fees collected from retailers.

Other banks that have the most to gain from changes in the rule, according to Keefe, Bruyette & Woods, include Synovus Financial Corp. in Columbus, Georgia; Regions Financial Corp. in Birmingham, Alabama; and BancorpSouth, Inc. in Tupelo, Mississippi.

Not surprisingly, TCF announced yesterday that it was requesting permission to drop its lawsuit in the U.S. District Court in South Dakota, citing both the Federal Reserve final rule and the fact that it lost an appeal in federal court this week on the matter of a preliminary injunction.

“While we continue to believe that the Durbin Amendment is unconstitutional because it requires below-cost pricing and exempts 99% of all U.S. banks, we believe our lawsuit has served its purpose in demonstrating the unfairness of the Durbin Amendment and that it is time for us to move on,” said William A. Cooper, the company’s chairman and chief executive officer, in a statement. “The Federal Reserve Board’s final rule is an improvement from its initial proposal and recognizes many of the points we made in our case.”

It’s time for Plan B for the banking industry, following failure of Durbin delay

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Plan-b.jpgWith Congress voting down last week for the second time a delay in implementation of the Durbin amendment to Dodd-Frank, it’s time for the banking industry to move on.

Brian Gardner, an analyst with Keefe, Bruyette & Woods in Washington, D.C. wrote in a note to clients Thursday that Congressional action on the Durbin amendment is now “a dead issue.”

Karen Thomas, senior executive vice president for government relations and public policy at the Independent Community Bankers Association, said: “I think it’s going to have to rest for awhile.”

The Durbin amendment is estimated to wipe out $15.2 billion in annual debit card fee income by capping the fee banks can charge retailers for debit card transactions, according to R.K. Hammer Investment Bankers, a bank card advisory firm.

Although the regulation states only banks with more than $10 billion in assets will be impacted, many believe the impact will be felt even at much smaller banks, which Bank Director Editor Jack Milligan explained here.

Gardner expects the Fed to release its final rule on debit interchange fees within weeks (the rule takes effect July 21). Like other analysts, he expects the 12 basis point cap on fees to be the floor and that “the final rule will provide some relief to card issuers.”

Thomas said the Fed will have to consider the cost of fraud protection on debit cards, and she’s hopeful it will consider other costs as well.

So the focus has moved to influencing the final Fed rule, although at this late stage, that might be hard to do.

The bigger picture is that banks already have been making changes and will have a lot of work to do on their business models going forward: With slow economic growth, higher capital requirements and reduced fee income from products such as debit cards, how will some of them, especially the smaller banks, make money going forward?

Robert Hammer, chairman and CEO of R.K. Hammer in Los Angeles, argues that banks will now look for new sources of fee income.

“Fees will rise as an unintended consequence of the legislation, no matter how well intentioned the Durbin bill may have been,’’ he writes.

Among them, potential fees for customers who don’t use their debit cards very much. Already, banks have been scaling back rewards programs for debit card users.

But the fee issue is just one piece of the puzzle for banks that are looking now at the big picture of how to grow and make a profit in a slow economy.

Board members have become more engaged in these questions than in prior years, says Will Callender, a consultant for First Manhattan Consulting Group in New York.

“We are seeing more rigor around the strategic process,’’ he says. “In prior years, it was ‘we do (strategic planning) because we do this every year.’ Now, everybody is more involved and asking more questions. ‘What lines of business are critical? What’s our plan for growth or profitability?’”

Community banks will still offer free checking, and here’s why

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money-checks.jpgAt the biggest banks in the country, free checking is becoming a little less free.

  • Pittsburg-based PNC Bank, the fifth largest bank in the country by deposits, was the latest to whittle away its free checking account last week. Customers will no longer get reimbursed for out-of-network ATM fees if they don’t maintain at least a $2,000 average daily balance and they won’t rack up points for rewards on a PNC Visa credit card. But PNC Bank has decided to keep free checking, for now.
  • Bank of America hasn’t had no-strings attached free checking in years, according to a spokesman for the bank.
  • Wells Fargo & Co. did away with it in July of 2010. After acquiring Wachovia in 2008, Wells Fargo has been getting rid of free checking for Wachovia on a state-by-state basis as it consolidates the two banking organizations.
  •  Citigroup doesn’t have free checking for new customers, either.

With Congress regulating away tens of billions in fee income from banks in the last couple of years, including a rule that will slash large bank interchange income on debit cards by as much as 85 percent, banks are looking to do away with unprofitable deposit accounts.

Mike Moebs, an independent researcher who tracks account activity for bank clients and federal organizations such as the U.S. Government Accountability Office and the Federal Reserve Bank of Chicago, says the move away from no strings-attached free checking at big banks is opening up a lucrative way for community banks to steal customers from the big Wall Street and regional banks.

Most of the nation’s smaller banks and credit unions still have free checking, he says. They have smaller operating costs than big banks, so they can afford to keep offering it, he says. The average cost of a checking account is about $200 to $250 annually for a community bank, Moebs estimates. That’s compared to a cost of about $350 to $400 for a big bank, which has more branches, more employees and tends to operate less efficiently, he says.

Moebs estimates banks with more than $50 billion in assets controlled 45 percent of all checking accounts as of 2009, but that will drop to 35 percent by the end of this year, he says. That’s a loss of about 13 million checking accounts that will migrate to smaller banks and credit unions, he says.

Some credit unions have even added free checking to take advantage of that switch, Moebs says, going from 75 percent of all credit unions offering free checking in July of last year to 84 percent last month.

Banks with fewer than $50 billion in assets stayed about the same since July, with 62 percent of them offering free checking. Only about half of big banks had free checking last month, down from 64 percent last July.

Moebs said smaller banks can make free checking pay by selling other products such as automobile loans or mortgages. They also can attract small business owners, an important clientele for community banks, using the free personal checking account to nab their loan business.

While community banks may end up stealing some customers from big banks with free checking, the convenience of branch banking still will be a significant hurdle to overcome. A recent survey by J.D. Power and Associates found that advertising and branch convenience remain top concerns for customers looking for a new bank, and fees play a less important role.

Plus, big banks may succeed in holding onto the vast majority of deposits, even as they lose account holders who kept small amounts of cash in the bank.

Free checking may help community banks steal some customers. But it won’t make them profitable. That’s up to the bank.

Why Smaller Banks Should Worry About Interchange Fees

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If you’re a bank CEO or director, you’re probably getting a little tired of Uncle Sam reaching into your institution’s pocket and pulling out handfuls of cash. Last year it was the new federally-mandated restrictions on account overdraft fees, which threatened to deprive banks of an important revenue stream just as they were struggling to recover from the effects of a deep recession in the U.S. economy. Fortunately for the industry, a significant percentage of retail customers opted into their bank’s overdraft protection plan, so the economic impact has turned out to be less than feared.

But then along came the Dodd-Frank Act, which not only imposes a greater and more costly compliance burden on the banking industry, but also drastically reduces the interchange fee that big banks–defined as $10 billion in assets or larger–are permitted to charge merchants on debit card transactions. The Act directed the Federal Reserve to set the maximum rate for debit card transactions, and in December the Fed proposed a cap of 12 cents–down from an average of 44 cents per transaction today.

The Fed is still soliciting comments under its normal rule-making process, and is required by Dodd-Frank to finalize the new rate by April 21. A 12-cent cap would result in a 70 percent to 85 percent reduction in debit card income for large banks, according to an estimate by the consulting firm Raddon Financial Group.

As bad as that sounds (and it is bad), the outcome of this latest threat to bank profitability is far from clear.

Raddon Vice President Bill Handel says that large banks like J.P. Morgan Chase & Co. are already considering a variety of strategies to mitigate the impact. For example, J.P. Morgan is testing a monthly $3.50 debit card fee in Green Bay, Wisconsin. (Under the current system, merchants end up paying the interchange fee, while retail bank customers are able to use their debit card for free.) The bank is also testing a $15 monthly checking fee in Marietta, Georgia.

One possible outcome of the new fee cap is that large banks will have to start charging for things–like debit cards and checking accounts–that used to be given away for the purpose of attracting core deposits. “The ‘free’ environment that we have been operating under will cease to exist,” says Handel.

The only problem is, Raddon’s research shows that consumers have become so accustomed to getting their retail banking services for free that they will balk at paying a monthly debit card fee. Instead, they will be more likely to either reduce their debit card usage in favor of paper checks (which are more costly for the bank to process)–or look for a free debit card at a smaller bank that isn’t affected by the cap. And that would seem to give small banks a huge competitive advantage since they could still offer their debit cards and checking accounts for free.

Not so fast. Smaller banks might think they’re shielded by Dodd-Frank from the sharp economic impact that large banks will feel, but that protection might not hold up in the real world outside of Washington, D.C. Predicts Handel, “We don’t believe the less-than-$10 billion exemption will hold up over the long haul.”

Visa Inc., the country’s largest card payments company, has said it will adopt a two-tiered pricing system for debit card transactions, one for large $10-billion-plus banks that will reflect the new Federal Reserve mandated cap on fees, and a second system for smaller banks that does not place a cap on fees. But Visa and its smaller payments competitor – MasterCard Worldwide – are member associations dominated by the same mega-banks that will be most hurt by a 12-cent cap. Handel says it’s not logical to assume that large banks like J.P. Morgan Chase and Bank of America will passively sit by while they lose debit card and checking account customers to small banks that can afford to subsidize those products with their higher interchange income.

“[The card companies’] brands are backed by the big banks,” says Handel. “If the big banks say to Visa and MasterCard ‘You can’t continue to have a two-tiered system,’ they will have to listen.”

A company spokesman said yesterday that MasterCard had not yet made a decision on whether it will adopt a two-tiered system for debit card fees, but don’t be surprised if the 32-cent per debit card transaction advantage that smaller banks seem to enjoy thanks to Dodd-Frank ends up much, much less.

Top lobbyist to bankers: When the economy improves, the beatings will stop

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Public officials will spend less time slugging bankers when the economy improves, but Dodd-Frank will stick around, changing the rules in fundamental ways, says one of the top lobbyists in Washington D.C., for the financial industry, Steve Bartlett.

Bartlett, the head of The Financial Services Roundtable, represents 100 of the nation’s largest financial companies, including Fidelity Investments and JP Morgan Chase.

Speaking to a crowd of hundreds of bankers at Bank Director’s Acquire or Be Acquired Conference in Scottsdale, Arizona two weeks ago, Bartlett said politicians have been criticizing the financial industry because the economy is hurting.

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“The beatings will stop when morale improves,’’ he said. “It helps a lot for you to tell your story to members of Congress. Go to their town hall meetings and sit in the front row. They will be less inclined to beat the hell out of you the next time they make a public statement.”

Bartlett said he’s already noticed a change of tone in the Obama administration in the hiring of the president’s new economic advisor, Gene Sperling, and chief of staff Bill Daley, a veteran of JP Morgan Chase. Sperling once consulted for The Goldman Sachs Group. The Obama administration also has announced plans to review government regulations to weed out rules that seem burdensome to business and ineffective.

But the Dodd-Frank legislation passed by Congress last year is going to stick around, perhaps with only some changes here and there, Bartlett said.

He called the Durbin amendment’s limits on debit fees a “shocking” part of the legislation that will limit bank access to low and moderate income customers. (Editor’s note: Some bank analysts say more regulation is doing away with products like free checking for everyone, although free checking without a minimum balance requirement was getting dropped before Congress passed Dodd-Frank last year anyway).

But another fundamental change in Dodd-Frank is the shift away from simply requiring disclosure of the terms for financial products, Bartlett said. The new legislation requires that customers actually understand them, he said.

Dodd-Frank requires the new Consumer Financial Protection Bureau to end “abusive” practices and requires that disclosures be written in “plain language.” It goes on to say that the bureau should rely on consumer testing to figure out if those disclosures are understood. The specific language of Dodd-Frank asks the agency to consider evidence of “consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of consumer financial products or services.”

Bartlett said Dodd-Frank will not just impact subprime loans, but other types of financial products.

“It’s no longer what you say to your customers but what your customers understand,’’ he said. “The statute says that you as a regulated entity will be held to the standard: Did the customer understand it? Not whether you said it plainly.”

Travis Plunkett, the legislative director at the Consumer Federation of America, did not attend the conference, and he disagrees with Bartlett.

“He is vastly overstating the impact,’’ Plunkett said, adding that he doesn’t believe companies will be punished just because a customer misunderstands something. He said the law is taking care of a minor gap in regulation that has allowed companies to create products that are so complex, they are designed to hide fees and charges from consumers, he said.

Elizabeth Warren, who is charged with setting up the Consumer Financial Protection Bureau, has said she wants to clean up disclosures and get rid of the “shrubbery” inside credit card disclosures. To see the interview she gave last month on the topic, read the Associated Press interview.