Thanks to a series of laws passed by Congress and rules imposed by the Federal Reserve, fees for using credit cards and bank accounts have begun to decline appreciably, which is a real boon to consumers. The key question is: Will banks find other ways to hit customers with new charges to make up for lost profits? Among the possibilities: Hefty increases in annual credit card fees or an end to free checking.
"Banks will certainly try to maintain profits," says Adam J. Levitin, associate professor of law at Georgetown University Law School. "There's potentially a whack-a-mole problem, where you limit one fee and they just shift it to another fee, or they create a new fee. But certain kinds of fees are subject to more competitive pressure than others, and it may be hard for banks to raise them."
The latest blow to bank profits came last week, when the Federal Reserve announced that it was limiting late fees on credit card payments to $25, effective Aug. 22. Most banks had been charging $39 for late payments. If they want to charge the higher rate, they'll have to submit proof to regulators that their expenses justify a charge greater than $25.
The ruling also prohibits banks from assessing penalties that are higher than the credit card violation. For example, if a customer goes $5 over his spending limit, the maximum charge the bank will be allowed is $5, up to a maximum of $25.
The Fed ruling follows the implementation of the Credit Card Act on Feb.22 this year. The law prohibits banks from arbitrarily raising rates on existing credit card balances.
Reverse the Charges?
Nick Bourke, director of the Safe Credit Cards Project at the Pew Charitable Trust in Washington, D.C., estimates that banks collect about $10 billion a year in credit card penalties. With the new rules, those fees will be reduced by about a third.
Bourke estimates that between Jan. 1, 2009 and Feb. 22 this year, banks raised rates on about one-quarter of all existing cards, affecting millions of customers. The new rules require banks to review those increases and possibly reverse them if the reasons for raising rates are no longer justified.
"I think that based on our analysis of the law and regulations, there has been a lot more transparency introduced into the credit card market, and we're not seeing a big shift into new types of tricky fees and hidden charges," Bourke says.
Less Revenue From Credit Cards
So how will banks make up for the lost revenue? Citigroup (C) says in a June 16 research report on the financial services industry that large banks are expecting revenue declines of about 0.7% of their credit card portfolios in 2010.
"Going forward we expect higher upfront/annual fees, pre-emptive tightening of credit standards and new products (e.g. secured cards) to be partial offsets," the Citigroup analysis says. Secured credit cards involve a customer giving the bank a deposit to use as collateral against credit charges. The Citigroup report added that credit card portfolios at major banks are likely to shrink as issuers focus on lower-risk borrowers.
Bank accounts are another area in which banks are facing lower revenues.
A new Federal Reserve rule places restrictions on banks' ability to impose charges on debit card and ATM transactions in accounts that don't have enough money. In the past, banks would cover these overdrafts and impose an average $35 fee for each transaction. Many consumers complained that they had been hit with exorbitant fees of up to $300 over a single weekend because they didn't know their account was overdrawn.
The new Fed rule forces banks to get existing customers to agree to the terms of the overdraft plans by Aug. 15. In the past, overdraft fees were imposed automatically unless the customer opted out of the program.
BofA Backs Out of the Overdraft Business
Mike Moebs, CEO of Moebs Services, a Lake Bluff, Ill., research company, says banks earned $37.1 billion on overdraft fees on debit cards and ATM transactions in 2009. He expects that to fall to $35 billion this year because of the new restrictions.
Despite the new rules, Moebs says 20% of banks he surveyed had decided to get into the overdraft business recently, while only 18% had left it, leading him to predict there will be "an uptick in revenue" by early 2011. Another 17% of banks surveyed said they were lowering overdraft fees.
Bank of America (BAC) announced that it was getting out of the overdraft business effective June 19. That will cost the bank $600 million in lost annual revenue. From now on, BofA will decline debit charges and ATM transactions if a customer doesn't have sufficient funds to cover them.
Bye Bye Free Checking?
The change in overdraft rules may threaten the continued existence free checking accounts. According to a study by research firm Celent, financial institutions depend on the overdraft fees for 50% of their retail checking account revenue. It says about half of all checking accounts are unprofitable for banks.
Robert Landry, vice president of banking group services at Mercator Advisory Group in Maynard, Mass., notes that one way banks hoped to make up for the revenue losses on overdrafts was with the fees merchants pay on debit card transactions. But those fees may be sharply reduced by legislation now being considered in Congress.
Banks are hoping to raise revenue by branching into new services, Landry says. They include so-called payday loans, essentially advancing money to customers until the next paycheck at the highest interest rate allowed by state usury laws, and merchant-funded discounts, in which retail merchants team up with banks to offer discounts to debit card customers, earning the banks an additional fee.
Landry says a checking account costs a bank about $100 a year to maintain. In the past, it was funded by the consumer maintaining a minimum balance, which the bank would lend out at interest, and by account-specific fees like the overdraft charges. "At the end of the day, there isn't really free checking," Landry says.
You Get What You Pay For
Anne Pace, a BofA spokeswoman, pretty much agrees. But customers could avoid a $8.95 monthly account charge by either signing up for an account online, maintaining a minimum balance of $1,500 or by using the account for direct deposit of a paycheck.
'Where we're headed, although there's not a lot of specifics yet, is offering customers a continuum of products and services that better meets their needs and essentially allows them to bank on their own terms," Pace says. The offerings will range from a bare-bones account that relies mainly on ATMs and online service to more sophisticated offerings that will cost more.
"Each of these offerings provide a value, and there's a cost that comes along with that value," Pace says. "We hope to offer customers more choices moving forward for the way that they pay for that value."
Note the word "pay."