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Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.

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May 16, 2022

The Cost of "Free"

When I began my banking career in the early 1970s, we essentially had only three consumer payment methods: cash, check, and credit (or charge) card. My checking account had a monthly service charge, and the account permitted me to write 15 checks a month—any more than that cost me 15 cents each. The overdraft/nonsufficient fee was $15 per check. My credit card had an annual fee of $25.

Today, I pay no fees for my checking account, debit card, online banking services, mobile banking services, electronic bill payments, or electronic wallet. I pay no annual fees for my credit cards unless a card is a premium card that bundles other products such as product protection or roadside assistance. (Of course, my statement about free checking is slightly exaggerated—most banks impose some sort of monthly maintenance fee, which you can often avoid by keeping a minimum balance or having a recurring direct deposit.)

The banking and payments industry has invested billions of dollars in these free channels and products. But is there really such a thing as a free lunch? Have financial institutions (FI) adopted a benevolent social policy giving everyone the right to free banking services?

It’s more complicated than that. Publicly traded FIs answer to their stockholders, and even nonprofit credit unions must generate sufficient revenue to maintain their financial health. So how can they offer all these free services and products? I believe there are four primary reasons that FIs are willing to forego explicit pricing for their services. The first is competition. Banks must compete in their market with the pricing of their products and services along with other factors such as quality of service and convenience of location. Second, debit card usage creates significant interchange revenue for the issuing FIs. Third, core deposits are the lifeblood of an FI's ability to fund its credit-related, revenue-generating products. Fourth, the bundling of services like bill payment and direct deposit have been shown to create a level of "stickiness"—in other words, the bundling increases the level of dissatisfaction a consumer must experience to believe it is worthwhile to move their account.

Will the bundling of these free services continue, or will the evolutionary cycle return to more explicit fees? Many FIs have been announcing of late that they are eliminating or reducing their overdraft/nonsufficient fund (OD/NSF) fees. The Consumer Financial Protection Bureau estimates that FIs collected almost $15.5 billion in OD/NSF fees in 2019Off-site link, which was about two-thirds of their fee income. You have to wonder if fees in other products and services will increase to replace this lost revenue. What do you think?