Washington Post: Bank of America at a Crossroads (and possibly the end of free checking)

A Washington Post article details some of the travails of Bank of America. I'm less concerned with their travails and more concerned with the implications of regulation on bank fees:

Even as the government considers limits on the scope of the company's business, it is also squeezing its profit margins.

Bank of America, like other large banks, lured customers in recent years by offering checking accounts with no monthly fees, credit cards with no annual fees, mortgage loans with no closing costs, brokerage transactions with no commissions. It made money by charging penalty and service fees, drawing much of its revenue from a minority of its customers.

In 1990, for example, the credit card industry derived two-thirds of fee revenue from annual fees, and one-third from penalty fees. By 2004, the ratios had more than reversed, according to the Government Accountability Office.

A recent report from the consulting firm Oliver Wyman said that banks had become too reliant on such penalty fees, allowing most customers to pay little or nothing for services such as checking accounts while a small minority of customers carried the load. Banks will collect an estimated $39 billion in overdraft fees this year, for example, which the Wyman report noted is more than the $32 billion Americans will spend on vegetables.

"The situation is not sustainable, and cracks have begun to appear," the report said.

Legislators imposed new limits on credit card fees and interest rates earlier this year. Pending bills in both the House and the Senate would sharply restrict the ability of banks to charge overdraft fees without asking or telling customers. And the White House has proposed the creation of a new agency solely devoted to protecting consumers from abuses in financial transactions, a key part of its proposal to overhaul financial regulation.

Bank of America has started to wean itself from penalty fees. The company announced last month that it would offer a credit card stripped of features that have angered borrowers. The terms, streamlined to allow for complete disclosure on a single page, include a promise not to increase the interest rate based on missed payments or credit problems. But such a card can only be offered profitably to the bank's more reliable customers, who are less likely to incur fees.

In late September, Bank of America announced small changes to its overdraft policy, including eliminating fees on overdrafts below $10.

The next step, according to financial analysts, is that banks may start charging these reliable customers monthly or annual fees. It was once a standard banking industry practice to collect such fees on checking accounts and credit cards.

Banking analysts and industry executives warn that the changes will limit the availability of loans and other financial services.

"The unintended consequence is that the cost of banking is going to soar for consumers," said Richard Bove, a banking analyst at Rochdale Research. "If you can't keep increasing overdraft fees, 30 percent of the customers are unprofitable. What the banks will do is kick them out of the bank."

In summary, banks have effectively been using less reliable customers who incur various penalty fees (the majority) to subsidize the more reliable customers. Checking accounts with no maintenance fees and no minimum balance requirement are easy enough to find in the US, but not so easy elsewhere. If limits are placed on penalty fees, that effectively means we all will have to pay some fees to have accounts, and that folks who are less careful aren't penalized or just are living on the edge will not be penalized so much. I'm sure there are some who will complain bitterly. I think this is more fair because it's more transparent. The bank isn't depending on gotchas to make money - ergo they have less of an incentive to try dirty tricks so that you make mistakes.

What does concern me is the unbanked. As readers know, a number of US customers have no bank account and live off cash. I last blogged about this here. This impedes their access to credit and imposes a transaction cost every time they receive a check. This could theoretically be avoided by using a no-fee, no-minimum checking account. However, account maintenance fees are one of the reasons the poor cite for not using banks. I'm not certain if the fee restrictions will have any effect on banks or credit unions that serve mainly poor communities. Certainly, mainstream banks in poor communities will probably become less attractive because they'll have to charge higher explicit fees - and then the check cashing/payday loan system and its high implicit fees will take over. We need a solution either way.