The Reason Free Checking is Disappearing

By Chad Henage - June 26, 2012 | Tickers: BAC, C, WFC | 0 Comments

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I recently read an article by Amanda Alix of The Motley Fool titled, “Up With Fees, Down With Free Checking.” I'll say upfront that Amanda probably isn't going to like me much, because I'm about to tell you why I disagree with her article. It's too simple to attack banks and say how horrible they are. I'll take you through each of her arguments and shed my perspective on what really happens at your average bank. The truth is, banks can't offer free checking because new regulations have made it unprofitable.

How is Banking so Different from other Industries?

One of Amanda's main points, was that big banks are losing customers due to fees being raised and new fees being instituted. In a prior post, I mentioned Wells Fargo (NYSE: WFC) as a good example of a bank that charges a fee for having a checking account if you don't meet certain criteria. Amanda mentioned Wells, along with Bank of America (NYSE: BAC), and Citigroup (NYSE: C) as the three largest banks lost a combined 1.5% of deposits last year from customer defections. However a key point has been forgotten: banks are for profit institutions. When was the last time that you heard a company being berated for raising prices and thus increasing profits? Albeit on Wall Street but it's not often. On a regular basis, companies from Procter & Gamble to Chipotle raise prices to offset new costs or to increase profits over time. You don't hear investors saying things like “how dare Chipotle raise prices to offset higher input prices!” So my question is, why does banking differ from other industries?

Overdraft Fees and Interchange Fees – The Reason for No More Free Checking

In the last few years, every bank in the country has been affected by new regulations that cut overdraft income and interchange income. For some institutions, these changes meant millions, or even billions of dollars in lost revenue. Banks are owned by their shareholders, which means they have a responsibility to their ownership, to try to maintain or grow earnings to increase the value of the company. Amanda pointed out that banks say it costs them about $250 a year to host a checking account. She made the comment that “this sounds a little fishy to me since 96% of the biggest banks offered free checking just three years ago and not even 35% do so today.” Three years ago, if a customer had ten overdraft items, they got charged ten overdraft fees. Today that same customer might be charged five overdraft fees or none at all. This would depend on if they opted-in or opted-out, and whether they were paper checks, online payments, or debit card purchases. In addition, three years ago debit card interchange fees were higher. These huge changes to overdraft and interchange income are the reason banks can't afford to offer free checking.

How Much do Checking Accounts Really Cost Banks?

This isn't the first time I've heard Amanda's argument that it shouldn't cost banks $250 a year to maintain a checking account. Let's look quickly at the services banks offer on each checking account and you can see how fast these costs add up. First, the bank is required to provide a bank statement each month. Second, most customers want a debit card which requires separate record keeping and real-time updating when transactions occur. Third, most customers want online banking. This requires the systems and support not only to keep their User ID and password secure, but most customers expect 24 hour, 7 days a week, 365 days a year up time on the site. In addition, bill pay is largely free which is a straight cost to the bank. To support online banking, the bank has to have employees to answer technical questions, web developers to make sure everything is running smoothly, and the systems in place to make sure that everything is updated on a consistent basis throughout the day. Never mind the fact that the bank is required to be a good steward of these services and offer fraud monitoring. The bank also has this little cost called employees.

Each employee has to be paid a fair wage, they usually have benefits, 401k, etc. Managers and customer service reps routinely spend about one-third of their business day handling “servicing issues.” Helping customers balance their checkbook, answering questions about overdrafts, printing statement history, transferring balances, cashing checks, etc. None of these actions make the bank anything, yet employees are paid the same whether they are servicing an account or selling a new service or product. I don't want to write a book on all of the costs that banks incur just to open the doors, but you get the idea. It's much more than just printing a statement once a month. This $250 a year, works out to just $20.83 per month. Think about this, if one customer takes one hour a month of a bank manager's time, that manager only has to be making $40,000 a year for this $20.83 to be spent. Given that most managers meet with hundreds of clients per month, you can see how easy it is for a bank to spend at least $250 a year on one account.

Those Overdraft Fees

I know some people are going to disagree with me on this, but overdraft fees should not be an issue for anyone ever. Yes that's right I said ever. Overdrafts don't just happen, they occur either because someone makes a mistake, or they knowingly overdraw their account. Amanda mentioned that banks are charging fees for overdrafts not being paid back in a certain amount of time. There is a reason for that. If a customer overdraws their account they are literally taking a: no credit check, no application, no documentation, unsecured loan. Overdrafts are essentially a form of bank lending; this is not a free transaction. Historically speaking, if an account stays overdrawn for more than 30 days, the likelihood that the account will be charged off is very high. In addition, most articles I've read make it seem like everyone pays overdraft fees. That is far from the truth. According to a recent study, 70-75% of the U.S. population never gets overdrawn. Another 15-20% of the population gets overdrawn incidentally at a rate of about six times per year. It's the remaining 10% that are serial overdrafters who have seven or more overdrafts per year. So to be blunt, most of the fury over overdrafts is related to about 10% of the banking population.

Conclusion

Banks are not out to get customers. Banks are for profit institutions that are trying to deal with the ever changing regulatory environment. This might shock some to hear, but if the government had not changed the overdraft rules for the 10% of repeat overdrafters, it is very likely that free checking would still be the norm. So the next time someone wants to complain about the death of free checking, write a letter to your congressperson. Banks want to offer checking accounts, but losing money to offer an account is not something banks should ever do. They have a responsibility to their shareholders to make intelligent decisions and the death of free checking is just that, an intelligent response by banks to new regulations.

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