Consumer Fees: The Hits Keep Coming

Banks are scrambling to find new footing as lawmakers and regulators undermine one of the industry's profit foundations: consumer fees.

Federal rules on credit card practices instituted a year ago kicked off a year in which fee income, a large and dependable source of retail banking profits, came under assault on many fronts. Lawmakers and regulators instituted a series of policies that restricted the industry's ability to charge for everything from credit card overlimit transactions to checking account overdrafts.

And the threat to consumer fees is far from over. Lawmakers are considering bills that would further restrict overdraft fees and regulate credit card issuers' interchange fees. They also have begun making noise about automated teller machine fees.

Whatever the outcome of such continuing government scrutiny, the banking industry has been shaken out of its complacent reliance on consumer fee income.

"I don't think we have one [bank] customer that's not concerned about the possibility of all these things happening, including interchange," said Brian Shniderman, a director of the banking team at Deloitte Consulting LLP. "Many didn't anticipate that some of the things that have already happened would happen and would happen so quickly. Now I think there's this [mentality of] 'anything can happen and we need to be prepared for everything,' " including the possibility of ATM fee regulation and interchange caps.

Although the industry has long faced the threat of interchange regulation, the debate intensified over the summer, as merchants capitalized on consumer rage over late fees and other cardholder charges. 7-Eleven Inc. channeled that anger into a petition to "stop unfair credit card fees," which received more than 1.66 million customer signatures.

During his confirmation hearing early this month, in response to concerns raised by Sen. Charles Schumer, D-N.Y., Federal Reserve Chairman Ben Bernanke said his agency "would definitely take a look at ATM fees."

By all accounts, the largest — and most damaging — blow has already landed, with the Fed's new rule that, as of July 1, banks must get customers' permission before enrolling them in overdraft protection programs.

According to the consulting firm Novantas LLC, the banking industry reaped $36 billion, or more than half of its revenues on checking accounts, from overdraft fees last year. By contrast, net interest margin accounted for only $13.2 billion, or 19%, of checking account revenues — slightly more than the amount generated by interchange fees on debit cards. Novantas forecast similar figures for this year. But in the coming years it projected that as much as $17.5 billion of checking account revenues could evaporate as a result of the Fed's required opt-in provision. In a "worst-case" scenario where lawmakers pass bills that would further restrict overdraft protection fees, Novantas estimated that industry revenues from checking accounts could fall by more than 40% over the next two years, to $38.6 billion in 2011.

"At some banks, as much as 40% to 50% of those fees are in jeopardy," said Rick Spitler, a managing director at Novantas. "What are you going to do, close a bunch of branches? That's scary — but they have to take huge amounts of costs out."

Aside from cost-cutting measures, banks may eventually have to rely more on net interest income to expand the top and bottom lines.

"If fees are limited, the only other sources of revenues are lower deposit rates or higher loan rates. There's no place else to go," Spitler said. "You're making the banks' revenues even more dependent on credit as a result."

Some observers would welcome such a shift. "Overdraft fees for bankers are like heroin — they know it's bad for them (particularly in building the trust relationship with customers that they want), but the revenue just feels so good," Carol Coye Benson, a managing partner in the consulting firm Glenbrook Partners LLC, wrote in a November blog post. "The Fed's new rules are detox."

Many industry members said that, at least in the short term, they expect to see financial institutions compensate for the clampdown on certain consumer fees by reinstating or resurrecting others. For example, several observers said they expect to see banks make up for reduced overdraft and other fee income by increasing up-front, or "visible," fees on checking accounts. More than one person mentioned online bill payments, which many banks currently offer for free, as one area where they expect to see banks charging.

"Nothing prevents them from raising maintenance fees — 'what used to be free now costs $10 a month, and what used to cost $10 a month will now be $20' — or having more restrictions," said Gwenn Bezard, a research director at Aite Group LLC. Such restrictions could include charging for the privilege of writing checks or requiring the checking account holder to also have a savings or credit card account with the same bank, he said.

But ironically, the overdraft fee restrictions should make it easier for banks to raise the pricing on their checking accounts.

"It was difficult for banks to do it before: the entire industry was not facing pressures, and you always have the bank that was willing to give it away for free," Bezard said. "Now, if every bank is facing tremendous pressures, it's a lot easier to move in sync, to have everyone start charging maintenance fees, to start charging for bill pay, for instance. Why not?"

Duncan Douglass, a partner at the law firm Alston & Bird LLP, agreed that "so far all the legislation and related regulations has focused on particular types of fees, so we'll see different types of fees crop up. … The same thing with annual fees with credit cards: You lose the ability to make as much on fee revenue, so you end up with new and additional types of fees."

That strategy may work only if implemented in a transparent way, especially as Congress debates the creation of a Consumer Financial Protection Agency that would have oversight of such fees.

"I think one thing that banks will do better next time around is not leave themselves in the position of being subject to the argument that they tried to deceive customers for those fees," Douglass said. "If those are disclosed up front, it's hard for the CFPA, Congress, the Fed, whomever, to enact any legislation or regulation — there's nothing inherently wrong about charging a fee." That said, "none of this will be popular," he said. "But if you're already at the bottom of the popularity scale, now is the time to do it. The challenge is sort of the gamesmanship of who's going to move first, because inevitably the first movers tend to get the most attention and therefore negative reaction."

Such reactions can only do so much damage, Douglass said. "I'm not saying that Dodd and Frank and Maloney and others will like it" when banks add fees, "but at a certain point, you're saying banks shouldn't make money, and that becomes a tough argument, even for Congress."