As overdraft and other fees become huge profit sources for banks, critics see abuses
Business Week, 5-2-05
Chris Keeley went on a shopping spree last Christmas Eve, buying $230 in gifts with his debit card. But the New York University student's holiday mood soured a few days later when he received a notice from Pittsburgh's PNC Bank that he had overdrawn the funds in his checking account. While PNC allowed each of his seven transactions to go through, it charged him $31 a pop -- or a hefty $217 in fees for his $230 worth of purchases.
Keeley, who insists he had never requested any so-called overdraft protection on his account, says he wishes the bank had simply rejected the transactions. He would have preferred to pay with his credit card or simply put the items back on the shelf. "I can't help but think they wanted me to keep spending money so they could collect these fees," he fumes. "Thirty-one dollars for each purchase seems excessive." PNC says it doesn't discuss individual customers. The bank insists it's doing a service by covering checks and purchases that would otherwise bounce. "It helps our customers avoid the embarrassment of having a transaction rejected," says Dan Tuccillo, senior vice-president for product marketing at PNC. As for the fees, Tuccillo says they aren't unreasonable "given all the free services we offer to customers. I think we offer a lot of value." Later, the bank halved Keeley's overdraft charges.
Keeley's experience is becoming commonplace as more banks turn to service fees to maintain their profits as the mortgage boom subsides. Overall, banks raked in $32 billion in account service fees last year, up from $21 billion in 1999, according to SNL Financial, a Charlottesville (Va.) research firm. At some, fees have become such a powerful source of profits that they exceed earnings from mortgages, credit cards, and all other lending combined. At TCF Financial Corp. (TCB ) in Wayzata, Minn., for example, such fees represented 76% of profits in 2004, up from 52% in 2000.
This fee frenzy may seem paradoxical with so many banks trying to lure new customers with offers of "free" checking. According to Edmund Mierzwinski, U.S. consumer program director for Public Interest Research Group, a Washington consumer-advocacy outfit, nearly 30% of banks offer such accounts, up from 17.5% in 1999. Sure, most don't carry monthly maintenance fees -- instead, customers get hit with a myriad of other fees. At San Francisco's Wells Fargo, the fee schedule for California is 55 pages long. The charges include a $2 hit every time a customer with a low balance calls a service rep, $20 for closing an account within six months of opening it, and $30 per hour when a staffer helps a customer reconcile an account. Wachovia Corp. charges a $5-a-month fee for accounts that remain inactive for more than a year. "Free checking is just a come-on," contends Mierzwinski. "Banks are making their money on the back end from hidden fees."
Industry groups contest that viewpoint. "The vast majority of people who are managing their finances well are not incurring a lot of service charges," says Keith Leggett, a senior economist at the American Bankers Assn.
None of the new fees is more controversial than bounce protection. Howard K. Mason, a banking analyst at Sanford C. Bernstein, estimates it generates $8 billion in income for banks -- making up nearly 30% of all bank service fees. Critics say some banks market such offers too aggressively, in effect encouraging consumers to spend more than they have. In a Feb. 18 joint directive to banks, the Federal Reserve, Comptroller of the Currency, and the Federal Deposit Insurance Corp. warned banks providing overdraft protection that they "should not market the program in a manner that encourages routine or intentional overdrafts."
Critics also contend that bounce-protection fees, as high as $37 per transaction, are little more than high-priced credit. "If a bank lends you $100 and charges you a $20 fee -- and then you pay the money back in two weeks -- that's an annualized interest rate of 520%," notes Jean Ann Fox, director for consumer protection at the Consumer Federation of America in Washington. "It's worse than a payday loan."
Regulators are particularly worried that some banks provide the service even at automated teller machines. Customers with $50 in their accounts and $300 in overdraft protection could be told at an ATM that they have $350 available. If they withdraw $150, the ATM will still show $170 in funds (after subtracting a fee of, say, $30). In their joint directive in February, regulators said banks should first alert customers that they will incur fees -- and give them a chance to opt out of the transaction, just as they can do to avoid a surcharge when using another bank's ATM.
Most troubling to consumer activists is that most of the new fees fall on the poorest consumers. Many banks provide truly free services to wealthier clients in order to hang on to their assets. Mason, for one, thinks the poorest 20% of the country's 135 million checking customers generate 80% of the $12 billion in annual overdraft fees. "[Banks] have turned routine fees into punitive finance charges for individuals who have trouble making ends meet," says the Consumer Federation's Fox.
Many banks defend bounce protection. Bank of America., says it started offering it after market research showed that most customers wanted it. "We've heard from customers that they'd prefer to be assessed a fee [rather] than face the embarrassment of having a purchase declined," says BofA spokeswoman Alexandra Liftman.
But some banks don't charge for overdraft protection -- and execs at those banks say plans with fees gouge customers. "It's outrageous," says Dennis DiFlorio, president for retail banking at Commerce Bancorp. "It's not about customer convenience. It's just a way for banks to make money off customers." Commerce and others cover overdrafts automatically from savings or other linked accounts, or even charge customers' credit cards -- all without fees.
Regulators are starting to act. Three years ago, Indiana state officials warned the 128 banks chartered there that if fees worked out to an effective annual percentage rate of over 72% it "would be considered a felony." And some federal regulators warn that if banks don't pull back on some of the more egregious abuses -- such as marketing bounce protection too aggressively or providing misleading information at ATMs -- they won't hesitate to act. "If we see recalcitrant banks that don't change, you could see enforcement actions," warns one.
That backlash could hurt the industry's bottom line. Bernstein's Mason believes a regulatory crackdown could eventually cause bank earnings from bounce-protection fees to fall by 20% as banks are forced to disclose more to customers. For now consumers need to remember that at many banks there's no free lunch -- or checking accounts.