Banks losing big on free checking

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According to one banking industry analyst, on average, banks are losing money on free checking accounts, and are predictably unsuccessful at making it up in volume. From Victoria Finkle at American Banker:

The average checking account cost banks $349 in 2011, says Mike Moebs of Moebs Services Inc., a research firm. But the average revenue per account is just $268, implying a loss of $81.

That equation helps explain the thinking behind some of the recent, highly-controversial steps banks have taken to raise the prices their customers pay for checking accounts.

“Banking is a subsidized business,” says Hank Israel, a partner at New York-based consulting firm Novantas LLC, pointing to the fact that the profitable accounts balance out those accounts maintained at a loss. “When the plane flies full, coach covers the whole cost and first class is the profit,” Israel says.

But thanks to new regulations, including the Durbin amendment in the Dodd-Frank Act, which caps fees on debit interchange, the number of profitable customers is falling. Those fee caps, which went into effect on Oct. 1, are expected to eliminate more than $5 billion in annual bank revenues.

As Finkle notes, numbers like these speak to why we saw banks try to introduce debit card fees a few months ago. If you look at a typical debit card fee, it would have added up to about $60 a year in extra revenue per customer for banks, bringing them much closer to that critical break-even number.

But if you’re wondering why it was large national banks that socked customers with debit-card fees and not a local bank or credit union, here’s the other key stat from the article:

For the largest banks with assets greater than $50 billion, the average checking account costs between $350 and $450 a year, according to Moebs. Overhead, or the institutional costs not associated with a specific division or service, is what weighs down some of the largest banks, making it more difficult to cut costs, he says.

But he adds that for some of the smaller banks with less than $5 billion in assets, the costs are much lower — around $175 to $250 a year.

I’ve been skeptical in the past about Moebs’ contention that costs per checking account at big banks are higher than those at smaller banks, mostly because it seems really counterintuitive that large banks wouldn’t benefit from economies of scale.

But if Moebs has it right, when you add that to  the $10 billion-and-under exemption for Durbin’s debit card swipe-fee caps, it goes a long way toward explaining why small banks have remained really comfortable offering free checking, and large banks haven’t.

If big banks are really paying more than small banks to maintain customers’ checking accounts, that’s really bad. Big banks have the edge in technology and infrastructure, and that, combined with the scale they operate at, should make it much cheaper for them to keep a checking account going.

Fact is, if the average revenue from a checking account is $268 and a big bank is paying $450 a month to keep an account going, it’s going to take an additional monthly fee of $15 from every checking accountholder to close the gap, which seems much higher than what most people are willing to pay for a checking account right now.

It seems clear fees aren’t going to make checking divisions break even by themselves; it’s going to take some serious changes in the way big banks do business, including massive cost cuts, to get there.