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Will free checking disappear?

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The days of free checking in its purest form — no minimum balance required and no monthly service fees — are numbered. A new federal regulation regarding a controversial method of covering overdraft transactions is expected to curtail the fees banks receive. Fees, banks say, that help pay for services associated with free checking accounts. To recoup their losses, most banks will impose rules on free checking aimed at wringing more profit from customer transactions.

The rule, which takes effect July 1, makes overdraft coverage an opt-in service. This rule affects an overdraft service that most checking account customers are automatically enrolled in, not the standard overdraft protection which requires your signature and is linked to a savings account, credit card or line of credit.

Banks that offer overdraft, or bounce, protection will send opt-in notices to customers explaining the service. Banks will not be allowed to charge a fee for paying an overdraft that occurs because of an ATM transaction or a one-time debit card transaction unless the customer agrees. The rule does not apply to overdrafts that occur through the use of checks or ACH transactions such as bill pay.

Changes could cost billions

The Federal Reserve said it focused the rule on ATMs and debit card transactions because they have been “a key driver behind the growth in the volume and cost of overdraft fees,” accounting for 41 percent of insufficient funds transactions, according to one study.

Hank Israel, director at Novantas, a New York-based consulting firm to the financial services industry, says changes to overdraft rules could cost the industry billions in fees.

“You look at banks that rely heavily on fee income and they cross the gamut — and it’s unfair to leave credit unions out of here, too. This is going to go across the board in terms of who’s going to be impacted. What’s really sad is that some of these community banks — the ones that survived the credit crisis because of not having large commercial real estate portfolios — may get hammered by this because that meant they were probably a more traditional consumer-focused bank.”

Unfortunately, free checking is one product banks are targeting to pick up some of the slack.

“I don’t think free checking will completely go away but I think we’ll see innovation around free checking, and we’ll see a lot more segmentation of checking accounts. We’ll see some really creative products with fee structures attached to them,” says Ken Patrick, senior vice president at Fiserv, a Brookfield, Wis., company that specializes in financial services technology.

Patrick says we’ll likely see smaller banks paying interest on checking accounts, such as RewardChecking, as long as the customer fulfills certain obligations such as using their debit card 10 or 15 times per month, or having a check direct-deposited to their account at least once a month.

Larger banks may offer noncash rewards based on debit card usage. Debit cards, traditionally, haven’t earned reward points, but that’s changing. Some free checking accounts may not have strings attached but will be bare-bones, requiring online-only access, no tellers, no drive-up — ATMs only.

Some banks are already steering customers in that direction.

Chase offers Chase Checking, no minimum balance required and no monthly service fee as long as you have a direct deposit or post five or more debit card purchases to your account each month. Withdrawals from an ATM and cash advances don’t count. If you don’t fulfill the requirements a $6 fee will be assessed per month.

Fifth Third’s Rewards Checking gives one point for every $1 spent using the bank’s debit MasterCard. Another point is earned for every $10 deposited through direct deposit. The bank waives a $3.95 World Debit MasterCard fee every month that the customer has $1,500 or more in monthly signature-based debit card activity.

Israel says a Novantas survey of 2,000 checking account customers nationwide identified six unique profiles, and that successful banks will consider a broad range of products to attract and keep these customers.

The six profiles are:

Runaway spenders — They want the money now even if it overdraws their account; they’ll pay the overdraft fee.

Predictability seekers — They’re in free checking now, but would pay a monthly fee if they know that fee is all they’re paying.

Information/control seekers — They have their phones rigged to tell them every time a transaction goes through, but they’re willing to pay a fee for the service. They see a value exchange with the bank.

Self-service — They’ll forgo checks, branches and gladly conduct their business online. But they’re so averse to fees that there’s nothing a bank can do to get them to pay for something.

Traditionalists — They want to talk to someone, they believe in free exchange and they don’t want rewards. They think if they get rewards they’re paying for them somewhere.

Rewards junkies — They’ll give the bank their business but the bank must give up something in return, e.g., better rates, etc.

The fact is the pool of customers who pay penalty fees is shrinking every year, according to industry statistics. Israel says in some institutions the decline is as much as 10 percent a year. Banks were already revving up new ways to make free checking accounts more profitable; the overdraft rules will simply speed up the process.