Brett King

The unintended consequences of the Durbin amendment

In Branch Strategy, Economics on March 26, 2012 at 09:38

In the UK and Australia, account keeping fees are nothing new. In the US, however, since the introduction of the Durbin amendment, many US banks have been moving to monthly fees on checking accounts (we call them current accounts generally outside of the US) for the first time. These moves have resulted in often massive backlash from the public, including social media campaigns, “Bank Transfer Day” and further fuel for the Occupy Movement.

In the US, there are actually people you meet who will tell you that free checking is, or at least should be, a constitutional right. Thus, emotion runs high when a bank suggests that you now have to start paying for the right to keep YOUR money with their bank – it’s an outrageous concept to many!

The biggest problem for the US banking industry is that for the longest time it trained customers to believe that this was exactly how they should feel, what they should demand. Advertisers promoted ‘free checking’ for decades as the basic hook for new customers, although it could hardly be called a differentiation. The logic is that there is nothing better than free to attract customers to a new service platform. So how did banks pay for ‘free checking’?

Not really free

Well, it was never actually free. Banks initially made money off deposits (or Assets under Management), but as regulations tightened in the last 2 decades, rates dropped and spreads decreased, margins became razor thin. In th 80s as interest rates climbed, some banks instituted basic fees to combat the cost of savings accounts, but when credit cards became popularized in the 90s, banks now had fallback sources of revenue in credit fees and interchange that could sustain ‘free checking’. A side effect of the Global Financial Crisis is that credit card usage has declined as consumer “saving has become the new spending”, this means that a credit card isn’t working as an offset against basic account costs. With interest rates at historical lows and with no immediate signs of improvement, basic account profitability is at further risk. Then to add to all of this pressure along came the U.S Senator from Illinois, Dick Durbin…

The Durbin amendment to Dodd-Frank, has cut off the lifeblood of interchange fee from larger institutions, many of whom claim it will cost Billions in lost revenue. So while account keeping fees are seen as a mechanism to claw back loses on interchange, I expect it will have a secondary, more subtle consequence on retail banking.

Branch Economics Fail

In the light of revised economics of interchange and debit cards, the first reaction to loss of interchange fee in the US was to try to find new sources of revenue. However, the second reaction inevitably will be a realization that the cost base banks carry to support checking accounts via the branch is no longer viable – network is simply a luxury in a world where consumers just aren’t utilizing physical spaces for their relationship. With the best customers only visiting branches occasionally as they become increasingly digitally enabled, the expense of sustaining a network for a core product or relationship which looks more and more like a cost than a profit, becomes rapidly apparent.

The UK has had more than a decade to deal with this, which is undoubtedly why the UK has halved the number of retail bank branches since 1990. The US, with the false economics of consumer credit and interchange, have paid for their bloated physical infrastructure without the realization of the cost of changing behavior on their distribution model. That realization is now hitting hard as the real costs of an outmoded business model hit home.

Unintended Consequences

The Durbin amendment will give banks the imperative to better manage the economics of their debit card and checking account business. As they are forced to be more disciplined around metrics, two issues will emerge. The first, that while the economics of branch banking are oft justified as supporting high-net worth customer interactions, that increasingly this demographic is moving to digital channels and the branch is no longer the lynchpin in this coveted relationship. How can it be when I use my mobile or internet to talk to the bank 30 times a month, but I visit the branch only twice a year? Secondly, the least profitable customers also are laggards to digital (largely due to adoption cost) and rely more heavily on tree-killing paper statements, ‘free’ checks and over-the-counter interactions.

Once you’re forced to re-examine your cost base in the light of changing distribution, behavior and regulation, the realization emerges that branches are not the profit centre they once were, but are now largely a cost that was hidden by the buffer of high interchange and credit card fees. Couple this with new challenges to the distribution model through Internet direct banks and non-bank FIs who offer better savings rates and lower fees on the basis of better economics, and branch banking will be mercilessly attacked by the big banks looking to retain their earnings-per-share.

The unintended consequences of Durbin may very well be the rapid unwinding of branch banking in the US. It takes a long time to turn the ship, but once that turn starts the momentum of branch closures will speed up rapidly.

Big Banks are like SuperTankers - they don't change direction easily

  1. I’ve worked for a “big bank” for almost fifteen years, and I’ve never met anyone who thinks free checking is a “Constitutional Right.” However, I have met those who know the bank uses their money in those checking accounts in a variety of ways. Checking accounts are often used to draw in other business such as credit cards, auto loans, etc. Disappearing tellers, lack of personal contact, fees on this and that …banks want to maximize profit and I’m all for it. However, they can’t take away services and up fees at the same time. (Well, they can but then they face the backlash you mentioned.) It seems most large businesses have forgotten that customer service is the key to keeping customers. If you take away the branch, then you need to make it easier for me to deposit checks, withdraw money, etc. We don’t mind paying for a service if we deem it valuable. (Case in point: My credit union recently introduced a servcie that allows me to scan my checks from home and deposit them into my account. Love it!)

    As for the Durbin Amendment and any other government regulation, I see it as (mostly) interference. I don’t know anyone who thought the consumer would benefit from capping fees – we were going to pay for it one way or another. Cap the fees and business will lower their prices? Not a chance! Cap the fees and think banks won’t find a way to replace the lost income by charging new/higher fees elsewhere? Far more likely. Thank you Uncle Sam!

    • Chris,

      Totally agree. I believe there’s a strong case for trade-off economics here, especially in promoting the right type of behavior from a cost-perspective that means the support or service channels that remain provide true service, rather than a transactional platform and poor support/service. The problem with needing the branch to provide service is both that the assumption is you do get good service in-branch (clearly not always the case) and we’ve trained customers that this is not what the branch is for. How often do you go in the branch and they get on the phone to solve your problem?

      I also agree that consumers expect to pay fee for service, the issue is when fees are leveraged and there’s no net gain in service.


  2. Agree 100% that is was the industry itself that trained consumers to think checking should be free. (When it never really was).

    But credit card interchange wasn’t what funded free checking accounts, and it wasn’t until relatively recently that debit card interchange helped to fund these accounts.

    On one hand, overdraft fees played a large part in funding these account (i.e, a relatively small number of account subsidized the overall market).

    But on another hand, free checking wasn’t funded or subsidized by anything. Free checking, in part, grew out of a belief that the checking account was an anchor account to a broader relationship. This has proved to be a terrible assumption.

    As for the turn away from branches, the industry’s response to Durbin has been 180 degrees wrong, and if it persists, won’t lead to a decline in branches. Instead of providing disincentives for using debit cards, the industry (in the US) should kill checks.

    Checks are a huge drag on the bottom line. It’s the depositing of checks that props up branch traffic. Kill checks, and you kill branches.

  3. Ron,

    As always your contribution makes enormous sense. There’s absolutely no reason for the inertia around checks as it stands today. Arguing that “it’s different in the US” isn’t an appropriate justification for an outdated payments instrument that has already been replaced throughout most of Europe with simpler, faster electronic mechanisms.

    I was at a first data concept in Las Vegas last year where 44% of the industry peeps in attendance said that checks were the most secure form of person-to-person payment. This is an industry in massive denial and just begging for disruption.


  4. […] Let’s take a broader view of financial services for a moment. Why have consumers reacted so negatively to the account fees that many banks have created? According to Brett King: […]

  5. Monthly fee on checking account makes their customers sad. Some banks offers free checking to attract customers which is actually not fee, it means they cheat on their customers to earn more profit.

    durbin amendment

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