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Small banks stick with free checking

By Claes Bell, CFA · Bankrate.com
Tuesday, August 30, 2011
Posted: 3 pm ET

It seems like every week brings another member of the banking industry's "Too Big to Fail" club announcing they're killing off free checking and introducing new fees. Plenty of consumers will probably just pay up, but if you're looking for a refuge from fees, smaller institutions are still an option.

For example, in this year's Credit Union Checking Study, we found 76 percent still offering no-strings-attached free checking accounts.

Small banks have also been holding the line on providing free checking, according to Maria Aspan at American Banker:

Moebs Services, which surveyed more than 2,500 banks and credit unions in June 2011, found that only 34.6 percent of banks with at least $50 billion in assets still offered free checking, down from to 96 percent at the end of 2009.

But almost 71 percent of smaller banks still offered free checking accounts at the end of June, according to Moebs, off just slightly from about 78 percent in 2009.

Aspan goes on to explain that one big reason many community banks are holding off on killing free checking is because they lack the market power to levy high-profile new fees and still retain their customers. That makes sense. Banking is a highly competitive industry, especially at the bottom of the size continuum, with banks constantly trying to poach other banks' accountholders with new offers and marketing campaigns.

Aspan's other reason, though, I find a little bit hard to believe:

Conversely, it costs less on average for smaller banks to operate checking accounts and they historically relied less on overdraft fee income, according to Moebs.

"Those that are in this huge bank group, they are truly beyond their economies of scale, and their expenses are usually high in processing areas," he says.

Customer service is one reason that small banks are maintaining free checking, but another is that they have a counterintuitive cost advantage, according to analyst Mike Moebs.

Big banks actually spend more on average to operate each deposit account than small banks, and they have long relied on overdraft fee income to help subsidize free checking. But a 2009 regulation restricted banks' abilities to charge overdraft fees, which prompted the first wave of cutbacks in free checking.

'Counterintuitive' is right; I'm not saying she's wrong, but Aspan doesn't really offer any concrete explanation of why big banks' checking account costs would be higher than small banks'. That's a little bit like saying electric-car innovators Tesla would somehow have a lower cost to build a vehicle than Ford or GM.

I'd offer another explanation: Small banks are waiting to see how the Durbin amendment's swipe fee limit shakes out before phasing out free checking. The Durbin amendment specifically exempts many small banks from the Fed mandated swipe fee limit of about 24 cents.

While many community bankers and credit union executives have predicted market pressure will force them to hold to that 24-cent limit as well, I think there's a chance that it won't, or that they'll be able to get at least a little bit more for each transaction. For what it's worth, MasterCard and Visa have both pledged to put in place a two-tiered interchange structure for debit card transactions.

I asked Greg McBride, CFA and Bankrate's senior financial analyst, about why he thinks small banks are holding off. He says in some ways, it's just a continuation of small banks' long-time business model: They've long relied on free checking as a way to get traffic through the doors so they can develop a relationship with customers that extends beyond checking into loans and other services that are more profitable, also known as "relationship banking."

"Small banks offered free checking long before the big banks did, and they'll likely keep offering it long after the big banks give it up completely," McBride says. "They've built their brand around free checking for a long time."

If you're interested in where free checking is headed in the banking industry overall, and McBride's insights on it, keep an eye out for Bankrate's authoritative annual Checking Study, which will run at the end of next month.

What do you think? Will small banks be able to keep holding the line on free checking, or will they follow bigger banks' lead?

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