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AmericasFebruary 1 2012

Fee criticism brings costs quandary for US retail banks

With traditional revenue streams taking a hit as a result of new regulations, retail banks in the US face a predicament. Should they risk losing customers by increasing their fees to cover costs, or is there another strategy that will appease shareholders and customers alike?
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Fee criticism brings costs quandary for US retail banks

There are fees that make money in retail banking and fees that make trouble. This tripped up Bank of America in late 2011, after it said it would charge individual customers $5 a month if they paid for store items with debit cards. The second largest bank in the US found itself in damage-control mode within a week of its initial announcement in September, amid a growing chorus of criticism demonstrated through online petitions, protests and comments by law-makers, up to and including president Barack Obama.

Witnessing the public relations nightmare, JPMorgan Chase and Wells Fargo decided not to go forward with introducing their own debit card fees. The only bank of 'the big four' (which also includes Citibank) to charge the fee, Bank of America scotched its plan on November 1, 2011.

Fees a must?

Whatever the backlash against Bank of America’s plan, it is not expected to reverse the industry’s trend toward a higher fee structure, given shareholder pressure to improve returns on domestic retail operations. The revenue deficit banks sustained following regulatory changes is the biggest factor pushing them on fees. Weak demand for consumer loans and higher costs tied to maintaining retail accounts made matters worse in the second half of 2011.

Retail demand deposits soared at leading banks in the second half of 2011, burdening them with higher deposit insurance costs and capital reserve ratios. Weak asset yields combined with a stalled economy left banks with cash they could not put to work.

There remains a great well of anger among the public about the role of financial institutions in our society. If I were a banker, I would remember that, and not raise too dramatically the costs of consumer fees

Travis Plunkett

“Most banks have no choice but to increase or, in many cases, introduce new fees to offset the massive losses [they are facing] due to the big regulatory changes and higher costs,” says Nicole Sturgill, director of research for retail banking and credit cards at Boston-based Tower Group. “[Banks] do not want to lose accounts but they need to profit more from existing customers, and they are okay with having them go elsewhere if they only keep a checking account with them.”

New York-based analytics firm Trepp says that big banks will increase consumer fees and reconfigure price packages to encourage a shift from debit card to credit card spending. In its recent report '2012 US Banking Sector Outlook', the firm predicts that average monthly charges and overdraft fees will reach $15 and $40, respectively, compared to the current averages of $12 and $35.

Sensitive subject

Bank of America, JPMorgan Chase and Wells Fargo and Citi – the four biggest financial institutions in the US – have begun to supplant lost revenues by charging more to service their tens of millions retail accounts, the vast majority of which represent the extent of a customer’s business with the bank. Because increasing fees is such a sensitive topic even in the good times, executives at the four banks declined to comment.

The banks are beginning to eliminate older generation, no fee checking accounts through brand consolidation, and are charging higher fees on newer accounts that offer fewer complementary services. The new threshold on minimum required balance is now $1500 for the lowest-tier accounts. Customers with balances of $15,000 or more, or whose business includes a mortgage, bank-issued credit card or brokerage account, have largely been unaffected. The initial plan by Bank of America for a debit card fee, for example, exempted mortgage holders, customers with $20,000 in combined balances, or with linked Merrill Lynch investment accounts.

On its mass-market products, Wells Fargo has upped its monthly fee from $2 to $5. Chase has increased the price of its 'total Chase checking' to between $10 and $12 a month from between $8 and $10 in 2010, the cost of Bank of America’s basic account has risen by 45% to $12, and Citibank’s fee on a similar product has been hiked by 25% to $10. 

Pricing has also been re-engineered to reduce customer visits to branches and generate more business per customer. The banks waive monthly charges in exchange for direct deposits of $250 to $500 a month, in combination with online activity, typically including online bill payments. Citibank offered this option to customers in one of its older generation accounts, 'EZchecking', and all mid-tier options. Otherwise, customers need to maintain between $6000 and $15,000 in ledger balances representing a variety of business.

Most banks have no choice but to increase or, in many cases, introduce new fees to offset the massive losses [they are facing] due
to the big regulatory changes and higher costs

Nicole Sturgill

Industry leaders are also tacking on additional charges; not to everyday transactions such as debit card purchases, but for more ad hoc activities, such as charging $5 to replace a lost debit card and $10 for incoming domestic wire transfers. Wells Fargo, for example, charges a $25 fee for basic account holders who need accounts reconciled. Fees also apply to some online transactions. US Bank, for example, is charging $0.50 for customers to deposit cheques via mobile phones.

Game-changer

There were two major rule changes that upset banks' long-time revenue streams and prompted them to start introducing different charging structures. The most recent was the Durbin Amendment, which took effect in October 2011 and set the stage for the backlash against the Bank of America.

A provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Durbin Amendment slashed the flow of interchange or 'swipe' fees merchants pay banks for debit card purchases by putting a price cap of $0.24 on each transaction versus an industry average of $0.44 previously. JPMorgan Chase stated in 2011 that this would mean the loss of $300m in revenue every quarter; Wells Fargo estimated $250m for a similar period.

Javelin Strategy & Research, a financial services consultancy, has said that the Durbin Amendment could ultimately slash $6.6bn in revenue from across the entire US banking industry.

What we are trying to respond to [at Bank of America], is how do we rebuild profitability because of the need to return to shareholders

Brian Moynihan

An earlier setback for major US banks was the Federal Reserve’s 'regulation E'. Starting in mid-2010, it prohibited banks from charging automatic overdraft fees for one-time debit card purchases and ATM withdrawals. Customers must now consent to these fees – which averaged $35 per transaction in 2012.

For the second half of 2010, overdraft fees across the banking sector fell to $30bn after the rule change took effect from July of that year, down from $38bn for the previous six months.

Overdraft charges had long supported profits at Bank of America, but the lender scrapped the charge rather than attempt to secure consent on a case-by-case basis. It still applies a $10 charge – similar to competitors – to transfer cash from other accounts to cover overdrafts.

Brian Moynihan

Brian Moynihan

One vestige of the consumer uproar over debit card fees is the continued push to have consumers close accounts at the biggest banks. Originally a one-day event in November called  'bank transfer day', it has been kept alive by various action groups, and could pose a problem this year when it is thought there will be more anti-bank demonstrations. JPMorgan Chase, Wells Fargo and Bank of America have all been targeted.

Bob Hedges, a partner at consulting firm Alix Partners in Boston, says that large-scale customer attrition at industry leaders is unlikely, but negative publicity could motivate the transfer of business to interest-bearing accounts at online banks such as Ally.com (formerly GMAC Corp), ING Direct and retail giant Wal-Mart.

But even the biggest banks can handle only so much news footage of beaming customers walking out of branches while brandishing withdrawal slips, to the delight of protestors gathered outside. “There remains a great well of anger among the public about the role of financial institutions in our society,” says Travis Plunkett, director of legislative affairs at the Consumer Federation of America, when asked if customer attrition would increase at big banks this year. “If I were a banker, I would remember that, and not raise too dramatically the costs of consumer fees.”

Mass market trade off

Gerard Du Toit, a partner at management consultancy Bain & Co in its North American financial services practice, believes that decreasing margins on mass-market retail accounts present industry giants with a predicament. Customers owning the accounts may not be profitable for them on a fully loaded basis, but they are still marginally profitable. For one thing, they give banks a broader base over which to distribute costs.

“This is a not a case when you shrink yourself to greatness,” says Mr Du Toit, the lead author of Bain’s 2011 report 'Customer Loyalty in Retail Banking'. “[Banks] need to avoid losing [such customers] to avoid undermining profitability, while adding mass affluent and small and medium enterprise customers to grow profits."

JPMorgan Chase, along with Citigroup, has the advantage of doing more business with mass affluent customers because they are anchored in the much wealthier, highly populated New York metropolitan region. Chase has honed in on a group it calls 'private clients', the so-called mass affluent customers who have $1m to $5m in assets.

“It is a group we have identified, and we now have set aside actual, physical space in our branches for them to cultivate relationships,” says a spokesperson for Chase. "We are committed to strengthening those ties.” Unlike its rivals, Chase is planning to expand in 2012 by opening a couple of hundred branches. 

Corporate overheads

Bank of America's CEO Brian Moynihan candidly characterised retail banking as insufficiently profitable after the changes of the past few years, as part of his response to criticism over his company’s plan to introduce debit card fees. “What we are trying to respond to, is how do we rebuild profitability because of the need to return to shareholders,” he said during a TV interview in Washington, DC, “and to provide all these great services for our customers, and at the same time, trying to be absolutely clear with customers.”

Retail costs for lenders vary widely. Using data from the Federal Deposit Insurance Corporation's (FDIC's) call reports for all 15,000 US depository institutions, Moebs Services estimated big banks spent $375 to $450 for each checking (current) account in 2011. The cost was $175 to $240 for lenders under the $50bn asset threshold. This estimate includes interest paid, expenses tied to branch networks and company-wide functions such as compliance and human resources. However, corporate overheads account for more than half of these costs, according to Mike Moebs, president of the firm.

Record inflows into demand deposits hurt margins in 2011 for the industry’s leaders, as such accounts cost $1 in deposit insurance premiums for every $1000, and demand deposits have higher set-aside rates on reserves. According to the FDIC, JPMorgan, Wells Fargo, Citibank and Bank of America reported almost $97bn in new demand deposits in domestic accounts for individuals and businesses as of September 30, 2010. FDIC data reveal another 34% increase in such deposits for the first nine months of 2011, the most recent data available.

FDIC data also show roughly 75% of $400bn in new deposits across all US banks went to the largest institutions for the first nine months of 2011. JPMorgan Chase saw its deposits grow the most, by 55% to $139.6bn, for this period.

“That is extremely significant,” says Mr Moebs. “They cannot really lend it out or make any real money on investing it. It is a drain on profitability because you have a situation where assets are growing faster than equity capital, and hence reducing efficiency.”

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