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Reality Check on Service Fees
When deciding whether to impose service fees, banks need to consider consumer preferences as well as the competitive landscape. by DAN GELLER
May 2, 2012  |  7 Comments

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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dan geller
5/14/2012 6:24 PM

Hi Jennifer, Yes indeed, this would be an interesting analysis to conduct. However, in the absence of actual data on number of accounts nationally, I had to use deductive reasoning. For example, I wanted to test the hypothesis that during recessionary times, the increase in account balances is linked to a decrease in service fees on deposit accounts due to reduced punitive-fee activity (NSF etc.). I analyzed data from the 2001 recession, and here are the findings. At year-end 2000 (pre-recession), domestic balances where $4.2 trillion and service fees on deposit accounts were $24 billion. At year-end 2001 (recession), domestic balances where $4.6 trillion, and service fees on deposit accounts were $27 billion (up $3 billion). At year-end 2002 (post-recession), domestic balances where $4.9 trillion and service fees on deposit accounts were $31 billion (up $4 billion). Clearly, service fees on deposit accounts increased along with the increase in account balances during the 2001 recession.

jennifer brooks
5/14/2012 9:33 AM

Dan, I think Achim may have an interesting point to make, if you could look at deposit growth spread over number of accounts, the picture may look different. In the last few years, we have seen a large increase in the average balance of accounts, but not always in the number of new accounts. That may mean that consumers are "stockpiling" their deposits into existing accounts due to the economy/recession instead of actively using those accounts in a traditional way - which would likely create increased fee revenue..it might be something interesting to look into?

dan geller
5/7/2012 7:17 PM

Annette, in response to your question, Market Rates Insight in currently conducting this consumer research, which will be completed by the end of this month. You may view more details on this research study in MRI’s Research Store - http://www.marketratesinsight.com/researchstore.aspx The name of the study is Integrated Study on Service fees. I hope this information is helpful to you.

annette szygiel
5/7/2012 2:50 PM

With respect to embarking on a three dimensional approach, by addressing three issues within our fee studies, what industry research provides the data to address these questions? How likely are consumers to use the proposed service? How much are consumers willing to pay for the proposed service? Some national stats would be helpful here.

mike branton
5/4/2012 9:56 AM

The most probable explanation for the decline with deposit growth is that the majority of deposit account service charges, other than NSF/OD, are monthly "maintenance" fees charges associated with a checking account. And the nature of the majority of these monthly service charges are based on a minimum balance requirement to avoid a penalty or "fall-below" fee. With deposits increasing in these accounts, the penalty fee comes into effect less frequently so service charges decline. However, I would contend that the rear view mirror analysis of the cause is less important than where banks are positioned in terms of fees today - Fee income is declining. Banks have to figure out a way to get more fee income on a fair exchange of value basis to not anger their customers, especially their profitable ones. This means not charging for things that have been given away for years and not depending on penalty fees. They also must figure out how to get more revenue from unprofitable DDA customers. This is the next big financial challenge for the industry as it relates to the deposit account side of the business.

dan geller
5/3/2012 3:49 PM

Achim, Your statement, “Service charge income on deposit accounts does not grow when deposits grow,” is factually incorrect. An analysis of the linear relations between service fees on deposit accounts and deposit balances in the past 20 years indicates an extremely strong relation (Beta .920), and very significant (alpha .000). Moreover, there is a strong causality (R-square .847) between the two variables. These findings suggest that an increase in deposit balances explains 85 percent of the increase in service fees on deposits.

achim griesel
5/3/2012 9:50 AM

Service charge income on deposit accounts does not grow when deposits grow - it grows when the FI can add customers. Over the past years deposits have grown, because money moved into banks, not because banks grew their customer base. The decrease in service fees started when the economy slowed down. One could probably make the arguement that overdraft income per customer, or better overdraft frequency, could be a leading indicator for an economic slowdown. When customers spend less money, they will have fewer NSFs. Lastly, my understanding is that Interchange Income does not flow into the service charge income on deposit account bucket. Am I wrong?