Last year I wrote a Forbes Finance Council article What's Missing in the CFPB's War on Junk Fees? That war was being waged against overdraft fees. I stated that comparing the fee assessed on an overdraft to the cost of processing one is like comparing the cost to manufacture a pill to the cost of the medication. It is short-sighted to isolate overdraft fees from the total cost to originate and maintain a checking account. If the CFPB was so concerned about fees charged by banks, perhaps they should perform an analysis of over regulation that is a key contributor to fees charged by banks.
Regulators must not have read that article. Because they have since expanded their war to include, among other things, debit interchange. Oliver Wyman said this in their Impact of Simultaneous Regulatory Proposals in Retail Banking:
"The Fed proposes under Reg II to decrease the maximum allowed debit interchange fee from $0.22 + 5 basis points to $0.157 + 4 basis points for issuers above $10 billion in assets. With a 2021 average ticket of $46.26, Reg II would decrease the average interchange transaction by ~28%. Debit interchange is a significant component of checking accounts non-interest income (around 50% according to data from payment card publication Nilson Report). Therefore, the proposed rule has a more significant impact on the profitability of low-balance checking accounts due to banks' relatively higher reliance on non-interest income for these consumers (versus high-balance checking accounts that rely more on interest income). Additionally, this may lead banks to start charging for fraud losses to recoup lost revenue - under Regulation E, banks are able to charge $50 for fraud losses to the customer, however, most banks cover those losses for their customers."
I should point out that when the Durbin Amendment of the Dodd-Frank Act (2010) capped interchange fees, it did not result in any measurable benefit to the consumer. Why take a second bite at the apple?
In my Forbes article, I demonstrated that banks' reaction to downward pressure on fee income, be it overdrafts or other fees, was to increase their average deposits per account. Meaning that they started focusing on more affluent customers that tend to carry higher balances so they can offset the fee decline by driving more spread through the account.
Yet here they go again. And Oliver Wyman is what I believe to be correctly assuming that banks will make moves to cover the revenue shortfall from debit interchange mandated by Reg II. What do regulators think will happen?
When I look at the average cost per retail checking account, be it interest bearing or non-interest bearing (see chart, courtesy of The Kafafian Group performance measurement), I see consistency in operating cost per account.
This is in spite of the average balance per account in interest checking growing 44% between the first quarter of 2007 to the fourth quarter of 2023. The average balance per account of non-interest checking accounts grew 152% during that same period. Banks themselves grew asset size to achieve that holy grail of growth, economies of scale. So why have we not lowered our average operating cost per account in retail checking accounts?
I cannot lay the sole blame at the feet of regulators. In every institution we have served with Process Improvement services we have found onerous processes, inefficient technology utilization, and silos prohibiting greater efficiency and therefore lower average costs per account. But many of those processes were belts and suspenders responses to regulatory scrutiny or the fear of that scrutiny in the bank's next exam.
If regulators work overtime to keep bank's operating expenses higher than need be through regulatory activism (see recent consent orders to BaaS banks around BSA/AML/OFAC compliance-classic checking account critiques) and keep pretending to be the Champion of the Consumer through price fixing regs like Reg II, expect financial institutions to rightly try to fill that profit hole. Be it through charging other fees or increasing minimum average balances that is suggested in the Oliver Wyman report, or through focusing on more affluent customers that carry higher average balances, as stated in my Forbes article.
Either way, will it end up better for the consumer? Look at how so many banks have significantly curtailed consumer lending. It's not because they don't want to serve their retail customer base with a more robust product offering. It's because regulation increased the cost so much and elevated the risk, that they drove many banks out of it.
Is that what we want?
~ Jeff
