In the past two years, major U.S. banks have been hit with a trifecta of new regulations costing them billions of dollars in lost revenue.
The new rules—which govern credit cards, overdraft fees and debit card transactions—generated a predictable outcry from industry members. They see regulators as trying to cut into their profitability at a time when banks traditional source of income, making loans, is proving difficult.
Still, of the three major headwinds facing the industry — weak loan growth, low interest rates and new regulation — dealing with the regulatory impact is proving the easiest to control.
“Banks are taking a very proprietary approach to fee strategy,” said Patricia Hewitt, Director of Debit Advisory Services for Mercator Advisory Service, a financial research and consulting group. Big banks have already made progress in recouping money lost from the new regulations, Hewitt said.
These three new laws will cost the country’s 20 largest banks $12.5 billion in lost revenue in 2012, according to Barclays analyst Jason Goldberg.
The banks are making up the lost revenue in three ways, Hewitt said: cutting expenses, restructuring existing products to be more efficient and profitable—and creating new products.
Cost-cutting is the easiest and most immediate way for these firms to make up for lost revenue.
"Now, most [banks] are looking at how services can be bundled into different types of accounts,”"
For example, Bank of America and Wells Fargo , the number one and two banks as measured by deposits, both have major cost cutting plans underway. Bank of America’s “New BAC” program aims to cut $5 billion in costs by 2013 and Wells Fargo’s expects to cut $1.5 billion in costs by 2012 under a plan called Project Compass.
Restructuring existing products is an evolving process for the banks, Hewitt said. As many bank customers know already, free checking accounts are harder to come by these days. This is primarily due to the Durbin Amendment and Reg E.
Durbin limits the fee banks can charge retailers for processing debit card transactions. Reg E requires customers to choose whether to receive overdraft protection on their checking accounts, preventing them from racking up charges unknowingly.
Before the laws went into effect, fees generated from these two services covered the cost of operating free checking accounts. That can be as high as $350 to $450 a year at big banks, according to Mike Moebs CEO of the economic research firm Moebs Services.
“Now, most [banks] are looking at how services can be bundled into different types of accounts,” said Hewitt. These bundled accounts can recoup lost revenue in three ways, the first being through additional fees.
More likely is that revenue will be recovered by banks increasing the audience of higher margin products that are part of the bundled service, Hewitt said. Banks may also use the bundling strategy to attract new customers looking for an all in one solution to their banking needs.
For example, banks might offer household accounts, giving a family a main deposit account tied to prepaid accounts used by children. This could expand the use of prepaid cards, or cards that carry a set amount of money that can be used by the holder. This would benefit the bank by increasing the number of higher margin prepaid cards it issues, and by expanding its brand to future generations who might one day set up accounts of their own at the bank.
The third way Hewitt sees banks recovering the lost revenue is the most tricky — charging fees for new products.
While banks have been aggressive in introducing new products over the last fifteen years, usually these products have been introduced without a charge. In this new regulatory environment, banks can no longer afford to give away new services for free. So to extract more fees from the bulk of their clients, Hewitt said banks will need to provide a level of convenience and newness to justify a fee.
What type of product might justify a fee?
Hewitt expects banks will begin charging for expedited bill payments. If your credit card bill is due today, for a fee a bank would post the money to your account, allowing you to avoid a late fee on the credit card, and avoid a hit to your credit report.
As for new services like depositing checks over your mobile phone, Hewitt said they are being offered for free. While some banks might put an incremental charge on the service, it might prove difficult. That's because clients will not tolerate higher fees on services they have come to view as free, such as debit card transactions, Hewitt said.
The outcry that ensued after Bank of America decided to impose a $5 monthly fee on certain clients for using their debit card resulted in two things, a black eye to the bank’s image and BofA’s decision to abandon the plan.
Banks are also making up the lost revenue by raising fees on services used less frequently, said Lee Manfred, a partner at First Annapolis Consulting.
Some banks are increasing the cost of replacing a lost credit card, or the cost of overdraft protection for a bounced check, he said. Still, the chance of banks completely recovering all revenue lost to these new regulations is unlikely, according to Manfred.
“I am skeptical if you get back to the pre-regulatory triple header,” he said referring to the revenue banks used to generate from activities now constrained by Durbin, Reg E and the Card Act.