A few weeks ago, I wrote a check from my checking account with one of the nation’s largest banks. To cover it, I had to transfer money from the account I have with my mobile banking company. This took a day longer than expected, and I was grateful when my bank cleared the check for me even though I had insufficient funds. It was nice of them.
But, of course, that’s not the full story. At some point in the distant past, my checking account was connected to an overdraft line of credit. The interest rate on this line of credit is exorbitant. There was no courtesy email to tell me I had a new balance on this credit line. I paid $58.47 for the “courtesy” of having this line extended to me for two days.
Overdraft “protection” can feel like a misnomer, as anyone who has ever been charged an overdraft fee — or a collection of them — knows. “Violation” would be a more appropriate term in many cases.
Americans pay billions annually in overdraft fees. And they don’t bear the burden equally. The Americans most likely to overdraft their accounts are those already living on the financial edge, where owing $140 in unexpected fees can be a major destabilizing event.
As I detailed in my last article, this affects millions of Americans. What these people could use are fee-free bank accounts and financial tools to help them save. But can big banks provide that?
Banks Need Money To Make Money
Banks make money in two ways. One way is through fees, such as overdraft fees, ATM fees, maintenance fees and late fees. Banks also charge fees for processing vendor credit and debit transactions, which are called interchange fees.
But banks make the majority of their money on customer deposits. The money people deposit into bank accounts doesn’t just sit there. Banks invest it or use it to issue loans — student loans, car loans, lines of credit, mortgages, etc. Banks collect a much higher interest on this money than the interest they pay to use it. For example, the average rate of interest incurred on credit cards in the third quarter of 2018 was 16.46%. Meanwhile, the national average interest rate on savings accounts at the time of this writing is 0.10%.
Multiply this process by millions of customers, and you end up with billions of dollars. That is, customers with healthy account balances. Customers who can’t afford to keep large sums of money in their accounts are a different matter. They don’t make banks money — they cost them.
Banks Are Handicapped By Vestigial Systems
Big banks came of age in a different era to serve a different kind of customer. This customer wanted to deal with a human teller and wrote checks for groceries. To serve this customer, banks needed brick-and-mortar establishments. Foot traffic mattered. Banks competed for prime real estate and signed long-term leases to lower costs. They hadn’t considered a future in which branches would become less relevant.
Banks also have all kinds of 20th century hangover expenses, such as cash vaults and cash handlers, check-processing facilities and armored trucks. They’re also stuck with the infrastructures for banking mechanisms, like checks, that could become obsolete someday but aren’t yet. A disproportionate amount of discretionary investment budgets goes toward updating legacy technologies and fixing compliance issues. This leaves little budget for reinvention.
Banks have spent a lot of time trying to figure out how to get out from under this enormous overhead, but they haven’t been very successful. And up until recently it didn’t matter, because they had been printing money.
This is why free checking accounts are becoming rarer. With so much overhead, low-balance accounts aren’t profitable. This locks big banks and cash-strapped Americans into a lose-lose relationship: Banks make money through these fees, often from the customers who can least afford them.
What Can Be Done?
For Americans struggling to achieve financial stability, big banks are not what they need them to be. The economics just don’t work. And there are many innovators in the digital banking space working hard to rise to the occasion. Of course, they face their own set of challenges.
Digital banks currently have narrow product offerings, which is why Americans haven’t joined them en masse. What if people need credit cards, loans or mortgages? They end up with fractured relationships across different digital banking services. But that is changing.
Digital banks are getting inside the regulated system. And once they can offer a full suite of products unencumbered by legacy overheads, traditional banks will no longer find themselves able to turn their backs on consumers. And if those banks don’t adapt, as the saying goes: The bigger they are, the harder they’ll fall.