Without overdraft fees, why would banks offer checking accounts?

There has been a significant populist outcry over the predatory overdraft fees charged by many of America's leading banks, and with good reason. In response, several banks have radically altered their overdraft policies, but that may not be enough to appease regulators. "We do need some regulatory standards in this area," said FDIC Chairwoman Sheila Bair said in an interview with USA Today. "We need the Fed to finalize rulemaking in this area."

Here's the problem with eliminating overdraft fees: It will encourage banks to turn away many low-income, low-asset customers, forcing them into the shadowy market of check cashing services, Western Union money orders, and payday lenders.
Back in the good old days, the way banks made money was simple: They took in deposits, paid interest on those accounts, and then lent the money out at a higher interest rate. The business of banking used to be described as "Borrowing money at 3 percent, lending it out at 6 percent, and being on the golf course by 3 o'clock."

But when people stopped saving money, that changed. With the exception of high net worth customers, the only way for banks to make money off of checking accounts is to nickel and dime people with bogus fees. That's how we ended up with the overdraft racket: It was a natural outgrowth of a fundamental shift in the financial habits of Americans.

So here's my question: If you have a person with a credit score too low to qualify for credit cards and an average account balance of $100 -- far too low for a bank to make any money lending with -- why would a bank accept that person as a customer?

In an interview with The New York Times, economist Michael Moebs said that 45 percent of the nation's banks and credit unions earn more from overdraft services than they make in profits. In 2009, banks are projected to rake in $27 billion on checking account overdrafts. Without those fees, many weaker financial institutions could fail.

Overdraft fees are horrible -- and better disclosure and an end to the gimmickry is an important step in regulating them. But without some plan to ensure that low-income, low-asset Americans still have access to the banking system, regulation in this area could well offer a cure worse than the disease.
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