Banking UP

The Federal Reserve today issued the final rules on the Durbin Amendment, and it’s an ultimate win for retailers, although I predict some battles to come from the banking industry and consumers before the dust settles.

The Amendment, part of the sweeping Dodd-Frank financial overhaul legislation, allows the Federal Reserve to put limits on the interchange fees that merchants pay banks when you swipe your debit card at their cash registers.

Today, those fees are ranging between 1% and 2% of the amount you purchase and have added up to $16.2 billion that merchants paid in 2010. As of October 1, 2011, the planned effective date for the new rule, those fees will be a maximum of 21 cents plus 0.05%, nearly 48% percent lower than before for a typical transaction of $40.

Lower fees sound like a good thing, assuming the savings are passed on to consumers and assuming that the banks can still afford to run the networks that make debit cards work safely and reliably.

If they can’t, consumers will see new fees tacked on to their bank debit cards and will respond by moving to lower fee alternatives. That, in turn, will prompt the banks to innovate their financial products while being mindful of not letting hidden fees get out of hand, for fear of sparking the regulatory backlash cycle all over again. And in the end, I predict consumers will gain fair, simpler, more transparent banking options, and retailers won’t be left holding the bill. But it will take a few tries to get there.

For background on hidden interchange fees, read Why You Should Care About Hidden Interchange Fees in 2011

For the details of today’s ruling, read the Fed memo posted by PYMNTS.com

Disclosure: Plastyc, a company that offers prepaid card services (prepaid cards are a sub-category of debit cards)is not directly affected by the proposed interchange rules, which only apply to prepaid card issuers with assets of $10 billion or more.

This week in New Orleans, the Center for Financial Services Innovation organized its 6th annual forum.

Plastyc will be part of a panel session about the “Young and Bankless“.

I will be talking about the myths and realities of young people & money, and will outline guidelines for building a prepaid card optimized for the 18-24.

During tough economic times, many of us can get dangerously close to the bottom of our checking accounts several times a year. As checks may not clear in the order we write them, sometimes our balance will even go negative by accident.  This is the dreaded overdraft.

Many years ago, banks invented a curious form of protection against overdrafts: you are permitted to overdraft, so that you don’t get embarrassed by a bounced check or a decline of your debit card in the shop, but you are charged a fee for this tolerance. The overdraft protection fee punishes you for having gone negative on your balance, while you find some money to get back into positive territory.

In all fairness, banks are giving you a temporary credit while your balance is negative and they deserve to be compensated for it. But $38 Billion during a single year? That’s $126 for every single of the 300 Million Americans, including newborns and the millions without a bank account.

According to economic research firm Moebs Services, here are the yearly revenues from overdraft fees collected by US banks since 2005:

In 2010, under congressional and public pressure, banks and credit unions started changing the terms of checking accounts to ask for voluntary opt-in to overdraft protections instead of making it a systematic feature. That year, revenues from overdraft fees fell slightly back to their 2008 level.

In 2011, they are resuming their steady rise.

Not all of us overdraft our accounts. But those who do, tend to do it repeatedly. You don’t want to be part of the club of “frequent overdrafters”; this dubious distinction is costing hundreds of dollars per year.

Unfortunately, the people hurt the most by these fees are the ones who can least afford them.

The Consumer Finance Protection Bureau, which starts operating this summer, will certainly try to protect you against these overdraft protection fees and other abusive clauses hidden in bank disclosure statements that average 111 pages in length according to a report by the Pew Charitable Trust.
This is quite a long shot though. With steadily increasing revenues in the tens of billions, banks will not be tamed easily.

So, what are you to do to protect yourself? Oddly enough, don’t opt for overdraft protection: this is when the fees kick in. You could choose prepaid accounts that cannot overdraft and never charge an overdraft fee. Some of us in the financial industry are adhering to these simple “do no harm” rules, but we obviously need to do a better job of making our products known.

Consumers Union has just published a new report entitled “Adding It All Up: How Prepaid Card Fees Compare to Checking Account Fees“. The report mostly sides with checking accounts and criticizes prepaid cards as more expensive.

Just a week before, a report from Bretton Woods Inc. entitled “Comparative Analysis of Reloadable Prepaid Cards to Basic Checking Accounts and Check-Cashing” concluded exactly the opposite.

What the heck? As a consumer ready to do your homework, which of the two are you supposed to believe?

Both reports fail to look at your particular circumstances and needs, which have a large influence on what is the best service for you.

Here are a few examples

• Scenario 1: You live in a rural community and can become a member of a local Credit Union which operates just one or maybe a handful of branches. Chances are that you will be eligible for a free checking account and will receive good customer service. The not-for-profit charter of the Credit Union and its economic motivations are favorable to you.
• Scenario 2: You live in a large city, bathed with WiFi hotspots, you spend a lot of time in front of your computer and with your cell phone, and you always have a minimum of a few thousand dollars in your account.  You are likely to handle most of your banking needs online and can get a pretty good deal with a bank after having carefully chosen one you are comfortable with.
• Scenario 3: You are in neither of the above cases and you have decided to stay with a bank that distributes hundreds of millions of dollars of bonuses to its executives every year.  According to recent reports focused on the cost rather than the price of banking services, offering you a checking account costs the bank about $300 per year. This includes the cost of ATMs, branch clerks, and customer support. I can’t comment on the $300 number because I don’t know enough; let’s just say that it is only slightly higher than the real cost because banks have no reason to minimize it.

In summary, prices will range from a few dollars per month to a few tens of dollars per month. This is a factor of 10x.

So, analysts who need to pick examples among thousands of banks and hundreds of prepaid card account programs, will come up with any numbers within that large range, even if they have no particular axe to grind.

Besides ignoring the economic circumstances and motivations, these reports also forget to measure the value to you.
You could argue that rectangular pieces of paper (checks) and rectangular pieces of plastic (cards) are all the same, because they are so well standardized (which is a good thing).
In a sense, they are indeed very similar. I don’t know any prepaid card issuing bank that does not provide FDIC pass-through insurance to the cardholders. And because all prepaid card issuing banks want their cardholders to be able to receive tax refunds and other federal benefits in their cards, they now offer the newly required consumer protections under Regulation E.
And when you think about it, a checking account is also “prepaid”: unless you deposit money in it first, you can’t use it. Especially since overdraft protection is now tightly controlled.

There are, nevertheless, meaningful differences in the value to you as a consumer, such as Internet and mobile access to your money. Or budgeting tools. Or person to person payments options. Alerts. Cash-back rewards…
The real competition is in the value/price ratio. As a consumer, you need to shop for the best value at the lowest price, as a function of your needs and preferences.

While free and frequent reports like those published by Consumers Union and Bretton Woods are useful compilations of prices that are otherwise difficult to find, they paint only a very partial picture of the marketplace.

Look for descriptions of features and services, and ask yourself what is important to you, as a function of where and how you live.

Below is an excellent video created by Bank 2.0 author Brett King.

This is exactly what we are seeing at Plastyc: strivers provide the core of the growth among the under-banked, not fresh immigrants.

Their motivations for being prepaid card accountholders?

• Resetting their finances in a way that avoids further overdrafts (checking accounts) and debt (credit cards)
• Choosing a product that costs less, has good mobile access, and does everything they need

Visa estimates that strivers are about 48MM in the US. A majority of them is Caucasian, 30% African American, and 7% Hispanics.

Read the article by Zachary Ehrlich in MyBankTracker