Banks have spent much of the past year howling about revenue lost after financial reforms limited consumer fees, especially the billions they reaped from charges for covering overdrafts on debit cards. Those programs, though, remain highly profitable. While fee revenue will be down about 16 percent this year from its peak in 2009, it will top $16 billion, predicts Moebs Services, a banking consultancy. “Consumers are still getting hit really hard by overdraft fees,” says Rebecca Borné, an attorney at the Center for Responsible Lending, a consumer advocacy group.

As banks pushed a shift from paper checks to debit cards over the past decade, they began enrolling customers automatically in overdraft protection plans, with charges of as much as $35 for each overdrawn transaction. Banks say that lets the 185 million Americans with debit cards make emergency purchases even if their account is short. Consumers, though, soon discovered that a slice of pizza could cost almost $40 after overdraft fees. Last year the Federal Reserve barred banks from offering overdraft protection on debit-card transactions without prior consent from consumers.

A few banks, including Bank of America (BAC) and HSBC (HBC), have since stopped offering overdraft protection on debit-card purchases. (BofA in September announced a $5 monthly charge for debit cards to make up for lost fee revenue.) Others introduced or expanded overdraft programs. An informal survey by Impact Financial Services, which advises small and midsize banks, polled 150 community banks and found that 70 percent of them now offer overdraft protection, up from about half before the rules went into effect.

Many banks that offer the services have launched aggressive marketing campaigns to get customers to sign up. The banks sent letters and e-mails explaining the changes, at times with alarmist warnings that if they didn’t sign up their card might be rejected when they most need it. Some banks called customers who’d had transactions denied to persuade them to opt in. “We were surprised at the success rate,” says Jefferson Harralson, a bank analyst at research firm Keefe, Bruyette & Woods (KBW).

The marketing campaigns also succeeded in sowing confusion. A survey by the Center for Responsible Lending showed that 60 percent of consumers who chose overdraft protection did so in part to avoid penalties if their debit cards were denied, even though such fees don’t exist. Similarly, two-thirds said they signed up to sidestep charges for bounced checks, which actually are covered under different programs.

Related articles

• Big Banks Still Raking In Billions From Overdraft Fees (huffingtonpost.com)
• What Durbin’s Amendment Means for Your Debit Card Use (frugaldad.com)
• New Law on Bank Overdraft Fees & The “Courtesy” Overdraft Protection (christianpf.com)

Community banks and credit unions have a prime opportunity to capture business from big banks that are enraging customers by imposing fees on debit cards and checking accounts. But I would advise caution as local financial institutions approach this opportunity.

First, local institutions need to promote their benefits rather than the disadvantages of doing business with the big banks. Second, there are too many ways in which actions that we take now could come back to haunt the industry in two to five years.

What seems to be clear in the strategic picture is that the big banks have decided they can no longer support the consumer mass market in a totally free environment. Reductions in debit card and NSF income have reduced the viability of a free checking account on a stand-alone basis. Further, I would fully anticipate actions on the part of the CFPB in the future to impact some of the checking account profitability drivers. For example, it would not be surprising if the CFPB capped the NSF / OD charge on the basis of “cost” as the Fed did with Reg II. 

All this will limit the ability of checking accounts to carry their own weight – that is, to be profitable on a standalone basis. I believe the imposition of debit card fees, in the light of research that shows clearly how much consumers detest this idea, shows that big banks have little interest in pursuing or retaining the mass market for checking. They will not impose debit card fees on valuable accounts. 

In addition, I believe that debit card fees are a shot across the bow for Congress on credit card interchange. By being very direct that the reason for this debit card fee is the action of Congress and specifically Durbin with Reg II, big banks hope to lessen the possibility that Congress will go after credit card interchange income. 

The challenge for community banks and credit unions is this: if consumers do begin to migrate their accounts to local financial institutions, community banks and credit unions must be willing to take the bad with the good.

The bad is the single-service, low balance checking accounts which will need to be subsidized by the institution’s other business. The good is the accounts where relationships are built. If too many bad checking accounts are attracted and the institution is not successful in cross-selling, then at some point I believe they will need to move away from free and move towards a relationship-based pricing structure. In banking parlance, this is “exporting a capital adequacy problem.” Establish policies that minimize or prevent importing a capital adequacy problem. 

Because of these factors, I think banks and credit unions need to be cautious right now. Promote the value of relationship and community, and avoid bashing the banks too hard on the fees because I anticipate more than a few will move away from free in the next several years.

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