There’s been much talk lately of banks doing away with “free checking.”
The banks, the thinking goes, as a direct result of some of the new banking federal regulations stemming from The Great Recession, no longer have the un-checked ability to charge $35 and up as “insufficient funds” penalties (also known as “overdraft charges”) and the like, and are therefore going to be losing so much money that they have no choice but to make up the revenue from somewhere else.
And, the thinking continues, checking accounts are a likely place to make up that revenue because they are just not as profitable as they should be (for an inside-the-bankway view of checking account profitability, see here).
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Pretty much all of us have a bank in our lives.
And pretty much all of that pretty-much-all-of-us have either BofA, Chase, Citi, or Wells in our lives. You can think of them as The Banks which are also known as The TBTF Banks, which stands for The Too Big to Fail Banks. And if you want to take the jargon up another notch or two, you can just go with the too-cool-for-school 2B2F.
As best I can tell (I’ve asked a lot of folks for their opinions on this), most of us are not all that fond of The TBTF Banks in our lives, though many of us are pretty OK with them, and though we rather like the convenience of their ATMs and such. This grudging acceptance is especially noticeable among those of us who have not, in a long time, had to actually to anyone at the bank to ask them to do something for us, because there’s a strong, positive correlation between our mostly-OK feelings towards the bank and the length of time during which we’ve not had to ask the bank to do anything for us. Because that might be asking too much — might be a bridge too far.
Now, it’s true that many of us view The TBTF Banks as evil, especially after they made out like bandits in The Great Recession.
But it’s also true that many of us are at peace rather than at war with our own particular bank — we have a perhaps easy/perhaps uneasy truce with it.
But it is in our lives, and we have figured out how to have it in there, so all is OK.
Our own too-big-to-fail bank, then, is the devil we know.
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The devil-that-we-know too-big-to-fail bank is often one that we came to, not so much by choice, but by historical accident.
A lot of people, for instance, have Wells as their devil-they-know because Wells happened to buy another bank which served as their devil before then. Or some of us have, say, BofA in our lives because, when we were in college, it was the closest branch to where we lived, and we’ve been with them ever since (and, yea, we kinda like it when our ATM card shows that we have been a customer of theirs since the year 19-something’y something).
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Banks are asset gatherers.
In fact, asset gathering is their main purpose in life, second only to making money, and it is their main purpose in life second only to making money because, for a bank, asset gathering is the closest thing to making money after making money. Capiche?
So they roam the landscape, vacuuming up assets, growing by gathering, and then growing some more.
It follows, then, that one of the primary ways a bank measures its own success is the size of the asset base which it has heretofore gathered, and that almost every dollar of profit a bank makes is directly correlated with the number of dollars it has heretofore gathered.
So the more gathered-dollars a bank has at its disposal, the greater is its power to make money. It’s that plain and that simple.
This is one circumstance, then, where bigger truly is better, without mitigation, negation, override, proviso, qualification, restriction or hem-haw.
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But so far this bigger-is-better-when-it-comes-to-asset-gathering assertion has been just that — a bald assertion. Now let’s back it up with some explanation.
And let’s do that by taking a look at at a bank’s spread income and fee income — two of the many income streams enjoyed by a bank, and both of which are directly related to the number of assets the bank has gathered.
Spread income is part of the old fashioned world of banking — the George Bailey sort of banking — in which banks make their money by borrowing it cheaply and lending it out not-cheaply.
So a bank might borrow, say, $1 billion, and it might do so by having a great checking account product, which, say, requires a $2,500 minimum balance to avoid fees and which has, say, 1 million customers, and which, all told, therefore, can generate, say, an gathered-asset-base of $1 billion, free and available for lending out.
Are your curious how to get to that number?
Well, the arithmetic and further assumptions behind that $1 billion figure are these: assume that the bank has 1 million customers, and multiply that by, say, a $5,000 average balance per customer, to arrive at a total of $5 billion in total gathered assets, and let’s assume that 20% of those gathered assets is always available for the bank to lend out because the bank’s customers stay well above the $2,500 minimum balance requirement, and because that is what the reserve requirements placed on the bank allow it to lend out, so that, since 20% of $5 billion is $1 billion, the bank, based solely on the assets it gathered through this checking account product offering, has $1 billion of lendable gathered assets.
Nicely enough, the bank has borrowed that $1 billion at an interest rate of say, these days, anyway, considerably less than 1%, because today checking accounts pay zero or near-zero interest rates. But let’s say that, on average and over the long-run, the bank pays 1% to its checking account customers.
The bank then turns around and lends that money out at, say, 8%. So, even if the bank has to pay 1% on its borrowing of the gathered assets, it has a 7% spread, and that spread is plenty enough to cover loans that go bad while still generating a great profit to boot.
So spread income is the difference between what the bank earns by lending out money ($$$), minus its borrowing costs (¢) and minus losses from bad loans (¢¢¢), etc.
Spread income, then, depends on the size of the asset base the bank has gathered. More assets equals more spread income.
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Up above, though, we left out one of those nasty minus numbers: we left out the cost of managing the checking account. Doing so requires big machinery and a tad of labor — in dollar terms, probably much more capital ($$$) than labor (¢).
For instance, let’s say that it costs the devil-you-know $100 million to have a back-office capability, consisting of a big ol’ computer system, a big ol’ automated check handling system, etc., plus a late-shift of twenty employees to do the overnight day-to-day processing of checks for the bank.
And let’s also say that that machinery and labor is sufficient to do the work so long as the bank’s gathered assets are no greater than $100 billion, and that after it crosses that threshold the bank would need to spend $250 million more on its back office to cover the next $100 billion in gathered assets (I am totally guessing about these numbers . . . but their accuracy is not important to the point) (but, think about it: four banks divide up, say, 100 million households, so each has 25 million households, and each household has, say, an average of $5k with the bank, so that right there is $125 billion, and that doesn’t include the business world) (and with a bit of looking, it appear that this is ballpark right).
Now, do you think the bank’s CEO is going to be happy if the bank has $75 billion of gathered-assets? Why gosh no, because, at that point the bank has the capacity to handle another $25 billion of gathered-assets, with no increase in its machinery costs or labor. And do you think the CEO will spring for the extra $250 million when the time comes to pay for it, to allow for even more asset gathering?
So, here, too, the bank sees a lot of gain from gathering more and more assets.
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And what about the other revenue stream banks enjoy, as mentioned above, that of fee income?
Bank fees have become more and more important over the years, accounting for a bigger slice of the bank revenue pie since deregulation in the late 1970s, with bank “noninterest income” going from 20% to roughly 50% of banks’ overall income during the period 1980 through 2003.
And how do you increase fee income? Well, there are at least three ways. The first way is to increase the amount of the fee. After all, why charge a $10 overdraft coverage fee when you can instead charge $35?
And the second way is to have more customers.
And the third way? Why, the third way is to try to help your customers fall prey to the fee by, e.g., hiding the fee ball, or by designing the fee rules to catch more inattentive customers.
So, here again, asset-gathering reigns supreme, with a well-earned second place going to having the political clout to have Congress on your side, allowing you to do as you please, including raising fees to absurd levels — something that, of late, the banks, for a change after 30-plus years of constantly increasing deregulation, have not had.
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Pretty much all financial companies are asset gatherers. And that is because, just like in the example above, the more assets they have gathered, the more money they can make. Period the end.
And that has a big bearing on how they behave.
For instance, if you want to move your stored-money from, say, Schwab to E*Trade because Schwab has treated you badly (it happens . . . ), then E*Trade will be very helpful in that process, while Schwab will be anywhere from mildly helpful to quite unhelpful (I once saw Merrill Lynch take a full year to let go of a pretty big annuity . . . ), because, for E*Trade, the assets coming in are an asset-gathering victory, so bosses and boss’s bosses at E*Trade will be happy, while at the Schwab end of things it is a defeat (unless Schwab sees you as a money-loosing customer, in which case it is a victory as well).
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The imagery that I like to use here is that E*Trade in this instance is like a bad horse heading back to the stable, because anyone who has ridden a bad horse in a bad tourist-trap horse-renting place knows that the horse will plod along as you walk away from the barn, but that, just as soon as you turn the horse a quarter of the way around to start heading back to its home, you had better watch out, because that horse will finish the rest of the turn for you without asking permission and will then, before you know it, gitty-up and act like it’s in The Kentucky Derby, a neck behind the leader and closing, and proceed to full-steam-gallop you all the way back to where some hay and maybe even some oats lay, and definitely to where you are going to get off its aching back. Get off my back and gimme some food!
So, too, with asset gatherers. When money is coming to them, they will run fast, jump high, salute when queried, and in all other ways impress and best-behavior Eddie-Haskell you.
The trick, then, is to see what the asset gatherer does once its asset-gathered from you. Does it still treat you OK?
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So, please remember: just about every financial services person you meet is, at heart, an asset-gatherer, and, remembering that fact and aided by that knowledge, when you first meet that asset-gatherer, please do ask that asset-gatherer to answer questions that can help you discern what that asset-gatherer’s true motivations are.
Does that financial services person just treat you well to gather your assets, or will that financial services person continue to do so long after your beautiful assets are gathered?
If you are of the age to know that song, I’ll just bet’ch’ya you can’t read those words without singing ‘e in your head. Am I right?
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And what of the banks and their free checking?
You better believe that they are going to be very careful about driving assets away — un-gathering them — with unfriendly checking account offers.
But, gee, if there are only four of them, BofA, Citi, Chase and Wells, then what’s to stop the BCCW Cartel from doing a nudge-nudge-wink-wink sort of communication — maybe even via stories placed in the popular media, using The Wall Street Journal and whatnot — to agree amongst themselves (though never speaking directly) that this would be a great time to un-do some of the freebies that have built up over the years in checking-account-land, like plaque on the walls of arteries, getting in the way of the flow of mega-dollar profitability.
So please keep your eyes out for the devil-that-you-know changing its checking account fee structure so as to coax more hard-won dollars out of you, but not so much that your dollars are likely to walk out the door and get on the nearest horse heading the other way.
‘Til tomorrow, then, here’s to your financial health and may it continuously improve.