Why I Support Reg E

Reg E required that banks separately and explicitly get customer permission for debit card and ATM overdrafts. This reduced the profitability of retail checking accounts by reducing NSF income to banks, making many checking accounts unprofitable. I discussed this in the Celent report, Reg, Reg Go Away: Sorry Banks, They’re Here to Stay, April 2010  I am in favor of Reg E, and actually believe it is good for the banking industry in the long run, even though as Maynard Keynes stated, “In the long run, we’re all dead.” I think transparency is a good thing for the long-term relationship between a bank and its customers. Clients who now opt in to overdraft know they did it, and are likely to pay the fees without rancor. Reg E isn’t new. Why discuss this now? I recently stayed at an Embassy Suites and saw the following message on my water bottle:

It’s In Your Hands.

Please Recycle.

Be Green.

reg-e-2 You’d think that Embassy Suites was into preserving the environment and encouraging recycling, but unlike many hotel rooms I stay in, there were no recycle bins in the room. So why the strong messaging?
Please Recycle

Please Recycle

If you look in the upper right hand corner of the label, in low contrast knock out type, you can see $4.95*. And if you attempt to read the fine print at the bottom of that label, you see (or don’t stand a chance of seeing) that if you drink this water $4.95 will be added to your room charge. While the recycling of the bottle might have been in my hands, I want to give Embassy Suites just a finger. This is exactly what banks are doing when they bury overdraft protection language in paragraph 23 of an account agreement and surprise their clients with a $33 overdraft charge. What do you create? Angry and disloyal customers. Is that any way to run a hotel? Is that any way to run a bank?

The Unintended Consequences of Regulation

Last week I attended Celent’s Innovation and Insight Day in Atlanta and had an opportunity to catch up with many of our clients, both banks and technology vendors. One of the banks told me an interesting story how after Reg E came into force, they saw a drop in debit card usage and a significantly increased demand for cash. As many of you know, Reg E requires a customer to opt-in to an overdraft facility for debit transactions at the point-of-sale. The regulation’s intention was good – to protect consumers from unexpected overdraft charges. However, the outcome was an unintended steer back towards cash at the point of sale. Many consumers didn’t understand the requirement to opt-in and having had their card declined at the POS due to insufficient funds in their current account, lost confidence in shopping with the debit card. If there is no easy way to check balance and there is a risk that the transaction might be declined, then it is easier just to withdraw cash and use that for purchases instead. As a result, the bank is faced with an unexpected increase in costs and efforts to forecast cash demand and replenishing ATM’s in time to meet that demand. According to a meeting notice published on its website, the Fed plans to meet on June 29 to discuss “Debit Card Interchange Fees, the Fraud Prevention Adjustment, Routing and Exclusivity Restrictions and related matters”. As the Durbin saga is nearing conclusion with the final rules expected to be announced after the meeting, there is a risk that this regulation will also have far-reaching and unintended consequences. Celent has just re-published an Oliver Wyman article series called “Durbin Second-Order Effects“. Oliver Wyman’s partner Andrew Dresner and the series’ author argues that by reshuffling the relative costs between debit, credit and alternative payments, Durbin will have as profound an impact on other actors in the payments ecosystem as it does on debit issuers. Do you agree? Do you have other examples of unintended consequences of regulation?

OD now DOA?

I just received a statement stuffer from one of my banks providing me “Important information for consumers about your checking account.” This is about the changes to Reg E. Consumers must opt-in to overdraft protection for one time debit card purchases and ATM transactions. This is a game changer in the world of retail banking and might spell the end of free checking. According to the FDIC, about 40% of all overdraft transactions are generated by such debit card transactions. If 50% of a retail bank’s revenue is overdraft revenue, the bank just lost 20% of its revenue. What to do? The first thing is communicate this message to your customers and find those who value the overdraft protection and will want to opt in. Banks must also understand their customers a bit better to figure out which are unprofitable today and which will be unprofitable under the new Reg E. Bundling products can help cross subsidize the current account which is typically the anchor account of the relationship. Consumers are used to paying fees for mortgages, credit cards, reward programs, etc. Can you create fee bundles for these products that make the checking account profitable? Can you negotiate across lines of business at your bank? The debit card was a game changer for the demand deposit account in a good way, lowering costs and increasing revenue via interchange. It may now become a game changer again, with few consumers opting in and revenue dropping, forcing banks to rethink the free checking business model. The big problem is that once customers have had something for free, they are unlikely to pay in the future.

Overdraft Fee Assault: Debacle or Dream Come True?

Recent changes in Reg. E requiring banks to institute mandatory opt-in provisions for courtesy overdraft programs weren’t a big hit with most banks – for good reason. NSF fees comprised 74% of total fee income collected by US banks in 2007 according to the FDIC, amounting to nearly $30 billion. Right or wrong, NSF fees grew to become an important contributor to checking account profitability among US banks. rev-per-acct This occurred alongside the growth of “free checking”. The end result was a bifurcated model for checking account profitability. A small number of high fee and high balance customers have subsidized the majority of low balance customers with limited NSF behavior. The latter customers used to pay monthly maintenance fees, but those vanished with the advent of free checking – along with the perceived value of bank services. The end result was unfortunate in a way. A majority of banking customers received banking services essentially free of charge and didn’t appreciate it, while a small minority of customers paid significant NSF fees (ostensibly due to their own negligence) and ended up offended. In addition, differentiating became difficult with most every bank offering generic free checking. There has got to be a better way to do things. Bank of America announced significant changes in its overdraft policy this week. Going well above the call of duty, Bank of America announced it will effectively eliminate overdraft fees caused by debit card transactions (through denial of those transactions) while preserving courtesy overdraft on check or ACH transactions in a highly transparent manner. Customers will also be able to obtain emergency cash at ATMs with explicit fee notices. Moves like this are likely to go a long way in restoring trust and confidence among consumers. Good brand building in other words. But, there’s more to this opportunity than brand building along. It may come to play that free checking as US consumers have known it will largely disappear as a result of the Reg. E changes. Opinions differ on the matter, but the associated revenue loss will be certain – and substantial. Many banks will be quick to seek alternative fee revenue. Savvy banks have a golden opportunity to use the heightened public awareness of bank fees to their advantage. The debacle can instead become a dream come true – an opportunity to redefine their value proposition. It won’t be easy, but opportunities like this don’t come around very often.