Friday, January 22, 2010

Unintended Consequences: Free Checking and Overdraft Fees

From the New York Times:

Banks earn billions in overdraft fees, money that helps pay for free checking.
A chunk of that revenue will disappear when some consumers elect not to sign up for the opportunity to spend more than they have. This week, Bank of America said that $160 million in overdraft fee revenue had already disappeared, because of changes it made in its policies ahead of the new federal rules.

Yesterday, I briefly mentioned loss leaders—or products that business lose money on in hopes of making it back somewhere else. Free checking is a good example. A checking account costs the bank money (they have to process your transactions, provide ATMs and banking centers, allow you online account access or mail you statements, etc.), but they are willing to give these services away because it may lead to you becoming a customer for more lucrative products. Maybe you'll take out a mortgage with the same bank, generating thousands of dollars in interest payments. You might stay at your current bank out of sheer convenience or laziness instead of shopping around for a better interest rate.

For many low-income customers, the banks relied on a significant percentage of them occasionally spending more money than they had, triggering hefty overdraft fees. Recent legislation would require customers to opt into overdraft protection (otherwise, their transactions will be denied if they don't have enough money). When the government makes it impossible for a business model to profit, it ceases to exist. Without those overdraft fees, free checking is likely to become a thing of the past.