Historically, overdraft fees have been the top earner in service-charge revenue for banks, but a recent study by economic research firm Moebs Services reports that is no longer the case.
Last year, for the first time, credit card interchange fees surpassed overdraft revenue as the top money-maker, bringing in $33.8 billion compared to $33.3 billion collected in overdraft charges.
“This is a major shift in how depositories have collected fees for decades,” says Michael Moebs, economist and CEO of the Lake Forest, Ill.-based company. “In 2006, a year of consumer economic prosperity, overdraft revenue was 53.2% of all service charge revenue. Credit card revenue comprised only about half of the total overdraft revenue.”
Impact of Durbin Amendment
The shift is a predictable result of the Dodd-Frank Act’s Durbin Amendment, which lowered for many banks the amount they could charge in debit card interchange fees.
Under the Durbin rule, the interchange price of a debit card transaction remains about 43 cents for depositories with assets of less than $10 billion, but bigger banks may charge only about 25 cents.
“It is easy to see why a depository would prefer to promote credit cards,” Moebs says. “Debit cards create 76% more volume than credit cards. Yet the credit card is more appealing due to its interchange fee being 250% greater.”
Rewards for customers—and banks
To entice customers to use their credit cards more often and for more big-ticket purchases, big banks offer rewards programs that provide prizes or cash back.
While such incentive plans cost less than a dollar per account for Visa, MasterCard, and American Express, they cost banks with less than $10 billion in assets between $20 and $40 per account, according to Moebs. Taking on that added expense may be imprudent for smaller banks, Moebs says, especially considering that 94% of banks already lose money on checking accounts and debit cards.
“If the smaller institutions are going to have a credit card reward program, it should be an internal financial services reward—if you accumulate enough points, you can have a reduced overdraft fee or a reduced fee on a loan,” he says. “That makes sense because it’s something they can control. The customer can’t get cash from them.”
Trying to duplicate the big bank rewards programs by giving away prizes is inadvisable for smaller banks because “they don’t have the volume and without volume, they can’t make money,” elaborates Moebs.
Where smaller banks can make money is by taking advantage of their edge from the Durbin amendment and increasing their volume of debit card transactions.
“The debit card is where the reward program should go for the small guys because there’s a price ceiling on the big guys,” Moebs says. “That’s an area where reward programs could really work for smaller institutions because they can get a higher [interchange] price, which can cover their higher costs.” (Nonetheless, Moebs recommends they again stick with an internal rewards program.)
Overdraft: new underdog
Another principal reason credit card revenue is outpacing overdraft profits is because the median charge for an overdraft has increased since 2010—driving consumers to payday lenders.
“Overdrafts are being whittled down in their potential revenue by third-party shadow competitors,” Moebs says. “In 2000 payday lenders were a little over 5% of the overdraft market. By 2017 more than half of people who overdraw go to payday lenders.”
That decision is perfectly understandable, Moebs explains: The payday loan is less expensive.
The average price of a $100 payday loan is $18, the same price a typical overdraft charge was in 2000. But since then, banks have raised the median price of an overdraft charge to $30— increasing the price of a service that has not increased in value.
“So the consumer says, ‘I’m not going to put up with that’,” says Moebs, “and who’s standing there to provide help? The payday lender.”
According to Moebs’ research, banks are beginning to realize they can keep that business in-house by lowering their overdraft charges. For instance, in the first quarter of this year, banks in the Washington, D.C., metro area dropped their overdraft fees by as much as $3.
“If you reduce your price on overdrafts, your volume goes up,” Moebs says. “If your volume goes up, can it go up enough with the new lower price that you’ll make more money? In the vast majority of cases, it does.”
Expect revenue sources to vary
If more banks lower their overdraft fees to retain their overdraft customers, the downturn in overdraft revenue may stabilize, Moebs suggests.
“I think what’s going to happen is that we’ve seen the price of overdrafts being inelastic, to where if you raise the price to about $30 you’re going to have a loss of volume. If you lower it, you will have an increase of volume, and if you do that correctly, you can make more money. It mirrors what the big guys are doing with credit cards,” he says.
Moebs expects credit card interchange will continue to lead revenue unless the Durbin Amendment is repealed, which will change the equation with debit cards.
“Different forces are acting on both,” he says. Cash is being used less, the debit card is taking off—and payday lenders are not going away.
“They’re providing almost half of the short-term necessary funding when someone doesn’t have enough money between paychecks,” Moebs says. “They’re criticized for charging $18 for $100? The consumers borrowing from them don’t even look at that. They look at banks charging $30.”
With credit card reward programs reaping profits for large banks, and the potential for debit cards to produce big winnings for small banks, Moebs predicts that overdraft revenue—the former king of service charge fees—will drop to third place by 2020.
The changes affect 90 million Americans and are unprecedented, he says. “What is going on in overdrafts, reward programs for credit cards and debit cards and the Durbin amendment, what’s happening in overdrafts—we’ve never seen anything like this.”
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