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Converting Basic Financial Services Fees into Prosperity
An Untapped Opportunity for Consumers and Banks


Quick Summary

12 percent of California households lack a bank account and pay fees to cash checks and pay bills, adding up to $700 annually for the typical unbanked household.  The majority of these households appears to be qualified for bank accounts, but is either misinformed about the relative cost of banks or distrustful of them.

Converting Basic Financial Services Fees into Prosperity
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Contact

Nicolle Grayson, Tel: 202-540-6347

Report Project

Safe Banking Opportunities Project

Findings

This section reviews the markets in California for four different sets of fee¬based basic banking services, specifically fees charged for a) overdraft and non-sufficient funds; b) credit card delinquencies; c) out-of-network ATM usage; and d) check cashing, most commonly used by unbanked households. For each of these, we use the survey data to profile the market size, the major market components, and the market drivers.28 

A. The Bank Overdraft and Non-sufficient Funds Fee Market

All depository institutions charge some type of fee when customers overdraw their bank accounts.29 These fees come in many varieties. The most prevalent is an overdraft service, by which the overdrawn balance is temporarily loaned to the customer for a fee. Most banks that offer this program lend money in increments rather than the precise amount overdrawn.30 Other types of overdraft protection include automatic transfers from one of the customer’s other accounts, and an automatic overdraft line of credit. Of these three types of overdraft protection programs, nearly all banks report in a recent study that the fee-based overdraft program is profitable, about 60 percent report that the automatic line of credit is profitable, and only 40 percent report that the linked-ccount program is profitable. In addition to overdraft protection programs, a small number of banks report that they charge a non-sufficient funds fee and do not loan the customer money to cover the negative balance. It is more common, however, for banks to offer an overdraft protection program that is available only to certain segments of its customer base. Overdraft charges were estimated in a recent GAO assessment of industry data to average about $25 per incidence.31 

B. The Credit Card Delinquency Fee Market

The fee structure for credit cards has grown increasingly complex over the last two decades.39 When credit cards were introduced in the 1950s, the only predominant charges were the card’s (fixed) interest rate and an annual fee. Today, consumers are faced with a range of other, more complicated service fees including: 1) late penalty fees, 2) over-limit (exceeding the credit limit) fees, 3) payment processing fees, 4) returned check fees, 5) cash advance fees, 6) convenience check fees, 7) balance transfer fees, 8) fees to make purchases in foreign currencies, 9) membership fees, 10) exchange rate fees, 11) card replacement fees, 12) revolving balance fees, 13) stop payment fees, 14) telephone payment fees, and 15) fees to obtain duplicates of account records.

In addition to a proliferation of service fees, variable interest rates have also become more common. A GAO survey of popular credit cards, for example, found that the annual percentage rate (APR) varies across types of transaction (e.g., retail purchases, cash advances), bill payment history (e.g., delinquency APR and cure APR), and credit utilization (i.e., over-limit APR). In addition, the majority of credit cards began to shift from charging a fixed APR to a variable APR in the 1990s, leading to interest rate fluctuations that the cardholder might not anticipate upon enrollment.40 According to the Federal Reserve’s semiannual Survey of Credit Card Plans, for example, 59 percent of the 150 credit cards surveyed carried variable APRs. All told, credit card APRs41 can range from about 8 percent to over 30 percent, depending on the type of transaction and the cardholder’s credit standing.42 

Since 1978, credit card interest rates have been subject to usury laws in the state where the credit card company (or division) is located. For this reason, most card issuers are located in states with nonexistent or very high interest-rate caps, notably Delaware and South Dakota.

C. The Out-of-network ATM Fee Market

Checking account owners that use an ATM outside of their bank’s network typically incur two separate fees. One fee is charged by the bank or retailer that owns the ATM (a surcharge fee) and the other fee is charged by the financial institution at which the customer’s account is located (an out-of-network or foreign ATM fee). The average surcharge fee (charged by ATM owners) in 2008 was $1.97, and the average out-of-network ATM fee (charged by the customer’s financial institution) was $1.46.51 Added together, the average customer using an ATM outside of his bank’s network incurs usage charges amounting to $3.43 per withdrawal.52 

D. The Check-Cashing Market

Over 26,000 non-bank institutions in the U.S. cash checks and sell bill-payment solutions, predominantly to households without a basic transaction account at a depository institution.57 Fees for check cashing are regulated by states and in California are as follows: cashiers are allowed to charge up to 3 percent (3.5 percent without an I.D.) of the face value of a government-issued or payroll check, and 12 percent of the value of a personal check.58 They are also allowed to charge a $15 fee for each bounced check and a $10 one-time account setup fee. Money-order providers are also regulated, although state law does not set a maximum fee. Research has found that non-banks tend to match fees to the maximum allowed rates, defying expectations about the effect of competition on rates.59 

Read Full Section: Findings (PDF)

Table of Contents
 

Date added:
Dec 12, 2008
Contact:
Nicolle Grayson, Tel: 202-540-6347
Project:
Safe Banking Opportunities Project
References:
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References:

  1. Authors’ analysis of data from the FDIC Institution Directory’s Statistics on Depository Institutions. Please note, however, that this growth in noninterest income has also substituted for income once earned by financial institutions through other means. For instance, consumers now pay fees for foreign¬currency transactions at ATMs in addition to or instead of at a foreign-currency vendor, once the primary mechanism for accessing capital in a foreign country. Similarly, Visa and MasterCard once added a 1 percent charge to any foreign transaction but now charge consumers a flat fee, which has the effect of moving “sales income” into the “fee income” side of a bank’s ledger.
  2. Authors’ analysis of data from the U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements.
  3. Estimate provided to The Pew Charitable Trusts by Moebs Services, Inc. For instance, Moebs estimates that consumers now pay $34 billion in overdraft fees every year. Note that a higher estimate published in a recent GAO report also includes enterprise overdrafts.
  4. Bankrate.com (August 2008)
  5. Please see, for instance: Appendix 3 in Matt Fellowes and Mia Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth-Building Potential” (Washington: Brookings Institution, 2008).
  6. For instance, for an analysis of how the checking account overdraft fee has evolved, please refer to: American Bankers Association Banking Journal, “Consumer Checking Account Challenge: Giving an old banking spud new profit appeal” (2004).
  7. General Accountability Office, “Bank Fees: Federal Banking Regulators Could Better Ensure That Consumers Have Required Disclosure Documents Prior to Opening Checking or Savings Accounts.” GAO¬08¬281 (Government Printing Office, 2008).
  8. Please see, for instance: Sumit Agarwal, John C. Driscoll, Xavier Gabaix, and David Laibson, “Learning in the Credit Card Market,” Working Paper No. 13822 (National Bureau of Economic Research, 2008); Barry Williams and Gulasekaran Rajaguru, “The trade¬off between bank non interest income and net interest margins,” Working Paper (Bond University School of Business, 2008); Nadia Massoud, Anthony Saunders and Barry Scholnick, 2007, “The Cost of Being Late: The Case of Credit Card Penalty Fees,” Chicago Meetings Paper (American Finance Association, 2007); Arnold S. Rosenberg, “Regulation of Unfair Bank Fees in the United States and the European Union: Current Trends and a Proposal for Reform.” In Evolving Legislation on Consumer Credit and Trade Practices, APS Occasional Papers 7 (2007) (Proceedings of 2006 Malta Conference of the International Association of Consumer Law on Consumer Protection Law in the European Union); Timothy Hannan and Ron Borzekowski, “Incompatibility and Investment in ATM Networks,” Review of Network Economics 6 (2007): 1-15; Sujit Chakravorti and William Emmons, “Who pays for credit cards?” The Journal of Consumer Affairs 37 (2) (2003): 208-230; Timothy H. Hannan, “Retail Fees of Depository Institutions, 1994-99” Federal Reserve Bulletin, January 2001; Christoslav E. Anguelov, Marianne
    A. Hilgert, and Jeanne M. Hogarth, “U.S. Consumers and Electronic Banking, 1995-2003” Federal Reserve Bulletin, Winter 2004; Joanna Stavins, “ATM fees: Does bank size matter?” New England Economic Review (Boston: Federal Reserve Bank of Boston, 2000); Joanna Stavins, “Checking accounts: What do banks offer and what do consumers value?” New England Economic Review (Boston: Federal Reserve Bank of Boston, 1999). Please see endnote 1 for examples of the substitution that has occurred in the market.
  9. For an example of the controversy surrounding these fees, please see: Center for Responsible Lending, “Overdraft Loans Trap Borrowers in Debt: Unfair bank practices artificially increase fees” (2008). Or see recent hearings on these issues, including: Overdraft Protection: Fair Practices for Consumers, Hearings before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Financial Services, 110 Cong. 1 sess. (GPO, 2007); The Credit Cardholders’ Bill of Rights: Providing New Protections for Consumers, Hearings before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Financial Services, 110 Cong. 2 sess. (GPO, 2008)
  10. Note, though, that having a lower income may also make a household more aware of its budget limitations than a higher-income household might be. We merely repeat this conjecture as an example of an opinion that has emerged in the context of little data.
  11. Again, we state this as an example of a conjecture that can emerge in the absence of data. While it is certainly true that debt-to-income ratios are high among middle-and higher-income households, too, multiple years of data from the Federal Reserve’s Survey of Consumer Finances make clear that this ratio is persistently higher among lower-income households.
  12. For some past insight into this question, please see: Jennifer Roth, “Walk-in Bill Payment: The Rational Option for the ‘Cash-Preferred’ Market” (Needham: Tower Group 2008); Center for Financial Services Innovation, “Underbanked Consumer Overview & Market Segments” (2008); and Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth¬Building Potential.”
  13. Bankrate.com (October 2008).
  14. Banks would have to open more accounts belonging to households in this group to achieve the same potential float as they would by opening accounts for households with higher incomes; also, it’s likely that fewer cross-selling opportunities exist within the former group. Large shares of unbanked households have low levels of education and speak Spanish, requiring higher levels of customer interaction, a primary cost driver in retail banking business models. There is also a large minority of unbanked clients with checkered account histories, indicating that there will be fewer qualified households returned from advertising investments in lower-and moderate-income markets compared to those made in higher-income markets. These facts make the basic lower-income market equation for bankers clear: lower relative benefits + higher relative costs = a less attractive business opportunity.
  15. We review in the Methodology section the full suite of fees that are now tied to basic banking services.
  16. Estimate provided to The Pew Charitable Trusts by Moebs Services, Inc.
  17. American Bankers Association Banking Journal, “Consumer Checking Account Challenge: Giving an old banking spud new profit appeal.”
  18. We want to be clear that we do not have usable data on the margins generated by these fees and therefore cannot reliably assess the extent to which there are excesses. For commentary along these lines, please see: Overdraft Protection: Fair Practices for Consumers, Hearings before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Financial Services; and The Credit Cardholders’ Bill of Rights: Providing New Protections for Consumers, Hearings before the Subcommittee on Financial Institutions and Consumer Credit of the House Committee on Financial Services.
  19. Emerging Markets, www.emergingmarkets.us (October 2008).
  20. One question was open-ended, asking the respondents to name the two magazines that they most frequently read.
  21. The sample was constructed to draw equal sample sizes from each of the state’s income quartiles. For one assessment of how the landline population differs from the mobile phone population, please see: Michael W. Link, Michael P. Battaglia, Martin R. Frankel, Larry Osborn and Ali H. Mokdad, “Reaching the U.S. Cell Phone Generation: Comparison of Cell Phone Survey Results with an Ongoing Landline Telephone Survey,” Public Opinion Quarterly 71 (5) (2007): 814¬839.
  22. CSRS terminated 344 interviews with respondents who did not know or refused to provide their income information; these households are not included in the final 2,001 count.
  23. CfMC is a commonly used survey research software.
  24. Information about these fees was collected from a number of sources including a) the authors’ analysis of bank websites, b) Bankrate.com (August 2008), and c) BankingMyWay.com (August 2008).
  25. For instance, please see: GAO, “Bank Fees: Federal Banking Regulators Could Better Ensure That Consumers Have Required Disclosure Documents Prior to Opening Checking or Savings Accounts.”
  26. Authors’ analysis of the American Community Survey.
  27. Ibid.
  28. For a helpful primer of bank-related markets discussed in this section, please see: Barry Scholnick, Nadia Massoud, Anthony Saunders, Santiago Carbo-Valverde, and Francisco Rodríguez-Fernández, “The economics of credit cards, debit cards and ATMs: A survey and some new evidence,” Journal of Banking & Finance 32 (8) (2008): 1468¬1483. For a helpful primer on the non-bank related markets discussed in this section, please see: Rebecca M. Blank, “Public Policies to Alter the Use of Alternative Financial Services among Low-Income Households” (Washington: Brookings Institution, 2008).
  29. For an analysis of how the checking account overdraft fee has evolved, please refer to American Bankers Association Banking Journal, “Consumer Checking Account Challenge: Giving an old banking spud new profit appeal.” For the purpose of simplicity, we use the term “overdrafts” throughout this section to refer to both overdrafts and nonsufficient funds even though the two are technically different activities. However, the rates tied to both services, as well as the account balance threshold that triggers them, are nearly identical.
  30. For instance, an overdraft of $37 might lead to a loan of $50 or $100 from a financial institution.
  31. GAO, “Bank Fees: Federal Banking Regulators Could Better Ensure That Consumers Have Required Disclosure Documents Prior to Opening Checking or Savings Accounts.”
  32. The phrase “past year” or “previous 12 months” throughout the paper refers to the period between May 2007 and May 2008.
  33. Estimate provided to The Pew Charitable Trusts by Moebs Services, Inc.
  34. Consider, for instance, a hypothetical household that had a checking account balance of $50 and was enrolled in a fee-based overdraft program. If this household were to write in one sitting four checks each worth over $50 and collectively totaling $250, they would pay four overdraft fees but likely recall it as only one overdraft incidence.
  35. Our data indicate that this group of high frequency overdraft users accounts for about 4 percent of the overall checking account market, but around 30 percent of all overdrafts (and, again, the data cannot distinguish whether these self-reported instances of an overdraft account for one or more fees at a time, so the overall share of overdraft revenue generated by this small share of households may be quite a bit larger).
  36. Allowable check-holding periods are governed under the Expedited Check Funds Availability Act, with implementing language in Federal Reserve Regulation CC. For a readable interpretation of these regulations, please refer to the Office of the Comptroller of the Currency’s guide to funds-holding rules, available at www.helpwithmybank.gov/faqs/banking_funds _available.html#drop03 (October 2008)
  37. For a full list of allowances please refer to the Office of the Comptroller of the Currency resource, cited above.
  38. In particular, the data indicate that households that have their paychecks directly deposited stand a one-in-four chance of overdrawing their accounts, compared to about a one-in-five chance among households that deposit their paychecks themselves. Although funds are more swiftly made available for households that directly deposit, it’s possible that the automation of this process may result in households being comparably less aware of their balances, spurring a modestly higher propensity to overdraw their accounts.
  39. GAO, “Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Customers.”
  40. GAO, “Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Customers.”
  41. Federal Reserve Board, “Survey of Credit Card Plans,” updated on January 31, 2008. Full list of surveyed credit cards and more details on each are available here: ww.federalreserve.gov/Pubs/shop/survey.htm (August 2008)
  42. GAO, “Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Customers.”
  43. Estimates based on data from CardWeb.com, Inc., which reports that the average U.S. household owns 6.3 bank credit cards. Please see: Kathleen Day and Caroline E. Meyer, “Credit Card Penalties, Fees Bury Debtors: Senate Nears Action on Bankruptcy Curbs,” Washington Post, March 6, 2005.
  44. It should be noted, however, that although nearly one in five households falls behind on its payment schedules, at least once a year, it’s unlikely that these households consistently pay their bills late throughout the year. Quarterly data from TransUnion indicate that, in the 15-year span between1992 and 2007, the credit card delinquency rate in California hovered between 1.1 percent and 2.7 percent. These data suggest that there is substantial churn in this market; households are slipping up once or twice in the span of year, but for the most part report that they pay off their balances according to schedule. This evidence of churn is supported by additional recent research that found paying a fee taught consumers to avoid paying future fees.
  45. Kathy Chu, “Facing losses on bad loans, banks boost credit card rates,” USA Today, February 8, 2008; R.K. Hammer Consulting Firm.
  46. For a recent assessment of the national credit card market, please see: Edward Castronova and Paul Hagstrom, “The demand for credit cards: Evidence from the survey of consumer finances,” Economic Inquiry 42 (2) (2004): 304-318.
  47. The sample included credit cards that were active between 1997 and 1999. Sumit Agarwal, Souphala Chomsisengphet, Chunlin Liu, and Nicholas Souleles, “Do Consumers Choose the Right Credit Contracts?” Working Paper 06¬11 (Federal Reserve Bank of Chicago, 2006).
  48. Nadia Massoud, Anthony Saunders, and Barry Scholnick, “Who Makes Credit Card Mistakes?”
  49. GAO, “Bank Fees: Federal Banking Regulators Could Better Ensure That Consumers Have Required Disclosure Documents Prior to Opening Checking or Savings Accounts.”
  50. Joanna Stavins, “Credit Card Borrowing, Delinquency, and Personal Bankruptcy,” New England Economic Review (Boston: Federal Reserve Bank of Boston, 2000).
  51. Laura Bruce, “2008 Checking Account Study,” Bankrate.com (November 2008).
  52. For other related work in this area, please see: Christopher R. Knittel and Victor Stango, “Incompatibility, Product Attributes and Consumer Welfare: Evidence from ATMs,” B.E. Journal of Economic Analysis and Policy: Advances in Economic Analysis and Policy 8 (1) (2008); Christopher R. Knittel and Victor Stango, “Strategic Incompatibility in ATM Markets.” NBER Working Paper No. 12604 (National Bureau of Economic Research, 2006); Elizabeth W. Croft and Barbara J. Spencer, “Fees and Surcharging in automatic teller machine networks: Non-bank ATM providers versus large banks.” NBER Working Paper No. 9883 (National Bureau of Economic Research, 2003).
  53. Please refer to the section that reviews the unbanked statistics for an explanation of this range.
  54. Greg McBride, “2007 Checking Account Pricing Study,” Bankrate.com (November 2008)
  55. For a recent assessment of the national market for debit cards, please see: Ron Borzekowski, Elizabeth K. Kiser, and Shaista Ahmed, “Consumers’ Use of Debit Cards: Patterns, Preferences, and Price Response,” Journal of Money, Credit and Banking 40 (1) (2008): 149-172.
  56. Some literature suggests banks have an economic incentive to over-supply ATMs because it increases out-of-network fee use and can be a lead-generation tool. For instance, please see: Dan Bernhardt and Nadia Massoud, “Endogenous ATM Networks and Pricing.” Working paper (2005).
  57. There are other basic financial service fees charged to segments of this group, such as those associated with prepaid cards, short-term loans, and wiring money abroad, but in this section we focus on check cashing and bill payments because these are the two most basic and widely used fee-based services within this group. Please see Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth-Building Potential” for a detailed analysis of the location of non-bank retail outlets.
  58. For a full list of state check-cashing fees, please see: Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth¬Building Potential.”
  59. Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth¬Building Potential.”
  60. Estimates of the unbanked market and its spending are based on proprietary models owned by The Pew Charitable Trusts’ Safe Banking Opportunities Project. We rely on both survey and external data to estimate the size of this market because of the difficulty associated with reaching unbanked households for telephone surveys. While the survey controls for this difficulty, we deemed the average of the two estimates (6 percent and 18 percent) to be a more appropriate measure.
  61. We considered running a structural equation model to determine different latent variable groupings, but concluded that it would be too difficult for industry to replicate this analysis with the available data. We also were unsure how industry would be able to find the latent variable groupings in the market with the available data. Further analysis is needed with data that are available to industry, such as an individual’s credit score, geography, employment, and so on.
  62. For instance, please see: Ellen Seidman, Moez Hababou, and Jennifer Kramer, “Getting to Know Underbanked Consumers: A Financial Services Analysis” (Chicago: Center for Financial Services Innovation, 2005).
  63. For instance, please see: Seidman, Hababou, and Jennifer Kramer, “Getting to Know Underbanked Consumers: A Financial Services Analysis.”
  64. For a recent discussion of this research, please see: Blank, “Public Policies to Alter the Use of Alternative Financial Services among Low-Income Households.”
  65. For a discussion of this research, please see Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth¬Building Potential.”
  66. Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth-Building Potential.”
  67. Please see section on overdrafts for a review of these fees.
  68. Unbanked spending estimates are based on a proprietary model owned by the Pew Charitable Trusts’ Safe Banking Opportunities Project.
  69. The economics of these products are often not attractive today for either financial institutions or consumers, curbing broad adoption. See, for instance, James C. McGrath. 2007. “General-use prepaid cards: the path to gaining mainstream acceptance.” No 07-03, Payment Cards Center Discussion Paper from Federal Reserve Bank of Philadelphia.
  70. Fellowes and Mabanta, “Banking on Wealth: America’s New Retail Banking Infrastructure and Its Wealth-Building Potential.”

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