Dan Geller May 2, 2012

Reality Check on Service Fees

The amount of money banks generate from fees on deposit accounts decreased from $36.2 billion in January of 2011 to $34.1 billion by year end, a drop of $2.1 billion or 5.8%. This is not an isolated incident; rather it is a trend that started five years ago. Income from service fees on deposit accounts fell from $39.2 billion in December of 2007 to $34.1 billion in December of 2011, a fall of $5.1 billion or 13%.

On the surface, it might appear that the decline in service fees on deposit accounts is the result of various regulatory changes governing service fees. However, an examination of the data shows otherwise. The revision of Regulation E, which provides consumers a choice regarding their payment of overdraft fees for ATM and one-time debit card transactions, became mandatory for compliance on July 1, 2010 and the caps on debit card swipe fees took effect in late 2011. While these two major regulatory initiatives might explain a reduction in service fees in the last two years, they can’t explain the decline in service fees that started in 2007.

Interestingly, the fee decline occurred despite an increase in the total amount deposited in banks. Since the beginning of the recession in December 2007, total deposits at FDIC-insured institutions have risen by $1.8 trillion, from $8.4 trillion to $10.2 trillion, a 21% gain. Normally, an increase in total deposits leads to an increase in the service fees associated with deposit accounts due to an increased level of depository activity. However, in the last five years the relationship has inverted: an increase of 21% in total deposits vs. a decrease of 13% in service fees.

If the decrease in service fees started three years prior to any relevant regulatory mandate, and if the decrease in service fees occurred despite a record increase in deposit balances in the past five years, we should look elsewhere for the main cause of the change. The culprit seems to be changing consumer preference.

Traditionally, consumers had little say in what type of products and services banks offered. However, with the advent of social media, mobile connectivity and instant transactions in the past few years, consumer expectations have risen, as demonstrated by last year’s fee protests during the so-called Bank Transfer Day. This means that banks, when considering their strategy around fees, need to research, analyze and implement services that consumers want and are willing to pay for.

It may have sufficed in the past to consider mostly competitor actions before implementing your own fees but no longer. Only a three-dimensional view, which also includes consumers' preference and price sensitivity along with competitor actions, provides relevant information for safer and profitable decisions on service fees. Otherwise, financial institutions expose themselves to the danger of consumer backlash.

A simple comparison of yesterday’s uncertainty associated with service fees to today’s additional uncertainty shows how much riskier and more complex service fee decisions can be:

Yesterday’s uncertainty:

  • Will consumers use the service?
  • Will consumers pay for the service?
  • What are competitors doing?

Today’s uncertainty includes those items but also:

  • Will consumers protest?
  • Will consumers move their business?
  • How will the new Consumer Financial Protection Bureau react?

Using the three dimensional approach, institutions would design their fee strategy by addressing three issues: How likely are consumers to use the proposed service? How much are consumers willing to pay for the proposed service? And what is the competition doing in regards to the proposed service? Using only one or two or these dimensions to make a decision increases the risk of unintended consequences. For example, if your competitive survey shows that none of your competitors is charging a fee on a particular service, does this mean that consumers will accept such a fee? Not necessarily.

Moreover, even if you find out those consumers are very likely to use a particular service, would this information, by itself, be sufficient to introduce such a service? Not really. While consumers may embrace a new service on a theoretical basis, they might not be willing to pay extra for it. Hence the need for an integrated study that brings together information on consumers’ preference, price sensitivity and the competitive landscape.

Mr. Geller is the executive vice president of San Anselmo, Calif.-based Market Rates Insight , where he oversees the research and analytics services of the company. He can be reached at dan.geller@marketratesinsight.com.

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