Financial services industry ; Banks and banking - Service charges

Gary C. Zimmerman

English

Research Papers in Economics

FRBSF
November 8, 1985 WEEKLY LETTER
Shopping Pays
The phase-out of interest rate ceilings and pay-
mentof interest on transaction accounts signifi-
cantly increased the interest income consumers
earned on deposits. While this benefit ofderegula-
tion was well-publicized during the early stage of
deregulation, attention has recently focused on
another effect: higher fees for deposit services that
have offset some of the consumer gains from
increased interest income. Indeed, as a recent Wall
Street Journal article suggested, "Since deregula-
tion, consumer groups say it costs more to put
money in a checking account and more to take it
out."
New charges, higher monthly fees and use charges,
and larger minimum balance requirements have
given rise to concerns about the affordability of
basic banking services such as transaction
accounts. Moreover, the increased use of charges
and fees has made it more difficult for depositors
to compare and evaluate the returns on the wider
variety ofaccounts now available. Concerns over
fees and disclosure have led consumer groups and
some legislators to push for "baseline" banking ser-
vices and full disclosure of the costs, as well as the
interest yields, of various bank accounts.
Legislation along these lines has already been
introduced in California and New York, as well as
at the federal level. Regulatory agencies are also
concerned, as evidenced by the Comptroller of the
Currency's August banking circular urging national
banks to provide a basic transaction account and
written disclosure of all fees, services and terms as-
sociated with it. Furthermore, such industry
organizations as the American Bankers Association
(ABA) have entered the discussion by recommend-
ing that banks continue to offer, or make plans to
offer, a low cost basic banking account.
Baseline services and disclosure
As typically proposed, baseline banking legislation
or. regulation would require banks to offer a basic
checking account to depositors at either reduced
costs orwithout cost, even though such an
account may have to be subsidized by the banks'
otherchecking customers or other operations. This
is not to say that many banks do not already offer
such an account. A recent ABA study indicated
that 45 percent of the largest banks and 60 percent
of the smaller ones either offer, or plan to offer, low
cost basic banking accounts. Such accounts pre-
sumably would be most attractive to "low income"
customers. The important features of the account
include a small initial deposit, either low ($100) or
no miminum balance requirement, reduced ($1 to
$3) or no monthlyaccount fee, and small or no per
check changes. However, the typical plan also
limits the customer's numberofchecks per month
(10 to 12) and provides only basic checking
services.
Legislated "disclosure" would require that banks
provide depositors with information on monthly
fees, use charges, minimum balance requirements,
interest yields, and other terms and charges associ-
ated with a depositaccount. Such disclosure could
help consumers evaluate the net yield (after costs
are subtracted from earnings) of the various types
of accounts offered at a bank, as well as compare
the accounts offered atdifferent banks. Stan-
dardizing this information could reduce depositors'
costs of "shopping around" for the best yield in the
same way that Truth in Lending laws provide for
standardized information on loan costs. Such a
plan w'ould be more appropriate now than it
would have been a few years ago because 95 per-
cent of banks now charge for services.
Deposits and banking services
In return for the deposits that consumers and busi-
nesses place with banks and thrifts, they receive a
combination of direct interest payments and/or
indirect service payments. In the past, ceilings on
explicit interest payments normally have deter-
mined the trade-off between how much interest
was paid explicitly and implicitly. During periods
when ceilings restricted banks' ability to pay
interest, banks typically offered services without
charge as compensation.
Banks provide both savings and transaction ser-
vices - check clearing and cashing, automated
teller machines (ATMs), teller services, account
statements, etc. Banks can charge for these ser-
vices through a combination of monthly fees, per
item charges, service charges, minimum balance
requirements, and/or by paying below-market
interest rates. When ceilings prevented explicit
interest payments, banks competed with oneFRBSF
another and with nonregulated institutions by
reducing the charges or offering services without
charge in lieu of explicit interest payments. Once
ceilings were removed, banks could pay higher
interest rates and hence no longer had to offer
"Iow cost" services to attract deposits. Thus,
removal of the ceilings resulted in more efficient
pricing and production of banking services, which
allowed banks to pay and consumers to receive
higher interest rates. Still, this transition caused
many depositors to face dramatically.increased ser-
vice charges and fees, which banks used to cover
the cost of offering interest-bearing accounts.
Trade-offs
The current structureof account maintenance fees,
per item charges, and minimum balance require-
ments illustrates the trade-offs between explicit
interest and irnplicit interest (underpriced services)
that still exist between noninterest-bearingand
interest-bearing accounts. Sheshunoff and Com-
pany, in a study entitled Pricing Bank Services and
Loans 1985, gives data for rates paid, average fees,
charges, and minimum balances based on a sample
of nearly 1700 banks. These data provide a very
useful indication of average charges for the banks
sampled as well as the wide range and varied com-
binations of charges across banks.
Transaction accounts that still have interest ceilings
in effect, such as personal checking and NOW
accounts, have lower overall fee structures (fees
and minimum balances necessary for free services)
than accountswithout ceilings. This indicates that
banks are constrained as to the interest they can
pay explicitly and are providing implicit service
returns in addition.
On personal checking accounts (for which explicit
interest still is not allowed), the monthly average
maintenance feewas $2.70. On average, banks
provided 15 free checks and charged 15¢ per
check above that number. Depositors, on average,
needed to maintain an average minimum balance
of$431 in their personal checking account for
banks to waive fees and charges. Also, because
personal checking accounts pay no explicit
interest,the depositor foregoes explicit interest
income on the balancesheld with the bank.
NOW accounts had a regulated maximum interest
rate of 5.25 percent,andgenerally paid that rate
during the survey period. Super NOWs, for which
interestpayments arenot regulated but for which
minimum balances of $1000 arepresently required
by regulation, yielded 7.81 percent during the
same period. Both had much higher fees and
minimum balance requirements than personal
checking accounts. The average monthly mainte-
nance fee on the NOW account was $6.07, and
the minimum balance necessary to qualify for free
services was $1,073. On the ceiling-free Super
NOW, the monthly charge was $7.64 to maintain
an account; the average minimum balance across
banks to qualify for free services was over $3,300.
If a depositor does not meet the minimum for free
checking with NOW orSuper NOW accounts, he
or she will often find that the cost of these
accounts exceeds the interest earned, and, in fact,
that the net yield may even be below that of a per-
sonalchec~ngaccount
Higher charges
By 1984, evidence of the rising cost of bank ser-
vices had led the Federal Reserve's Consumer
Advisory Council (CAe) to ask the Federal Reserve
staff to examine changes in the cost and
availability of bank deposit services. For depositors,
perhaps the most important factor in determining
the cost of maintaining an account is the minimum
balance requirement necessary to waive fees and
charges. Federal Reserve Staff Study #145 indi-
cated that, for the period from 1980 to 1983, rates
of increase in the minimum balances necessary to
waive service charges were similar to the increase
in the Consumer Price Index. This suggests that ser-
vices charges had not risen as sharply as some
were suggesting.
However, the study also found evidence that there
was a large increase in bank charges if one
examined the level ofcharges imposed when de-
positors' balances fell below the minimum neces-
sary to avoid service charges. According to the
staff report, such charges rose two to four times
faster than the general price level, reflecting the
elimination of the need to provide services in lieu
of interest Yet, this increase may overstate the
effect of rising charges and fees because the prices
studied were the stated or listedcharges that
banks set Many depositors avoid these charges
either by maintaining balances sufficient to waive
fees or by shifting their deposits to an institution
with lowerfees.
Moreover, looking only at banks ignores competi-
tive accounts offered by other types of institutions.
Savings and loans and credit unions may now pro-
vide interestcbearing transaction accounts (NOWs
and Super NOWs) to their customers. Surveys indi-
cate that, on average, the annual cost to a deposi-
tor of an account at a savings and loan is about halfthat at commercial banks. Furthermore, a recent
survey of credit unions, which benefit from a tax-
exempt nonprofit status, indicated that three-quar-
ters ofcredit unions have no monthly fees or per
check charges on their interest-bearing checking
accounts.
Although it may require some shopping on the part
ofdepositors to find the "best" deal, there are
"lowercost" services available. Because of these
alternatives, the impact of rising bank charges may
be avoided by many depositors even though the
Sheshunoff survey indicated that about half of the
banks surveyed raised charges within the last year.
Measuring the impact
Households typically state that the cost of transac-
tion services is far less important to them than are
such factors as convenience, available services, or
interest rates in selecting a bank. One reason for
this is that even at banks, most customers appear
to be able to avoid charges by maintaining
minimum balances that qualify them for free or low
cost services on personal checking, NOWs, or
Super NOWs. The Federal Reserve's 1984Cur-
rencyand Transaction AccountUsage Survey
found that 57 percent of householdssampled
were able to avoid charges on their bank accounts.
For some groups, such as seniors, the figure was
much higher - nearly 90 percent normally did not
pay directly for banking services.
Evidence on the importance depositors attach to
fees is also consistent with deposit ownership
behavior. The Federal Reserve Staff Study suggests
that about the same percentage (nearly 90 per-
cent) of households held checking or savings
accounts in 1983 as held them in 1977, before
deregulation began. Indeed, nearly 80 percent of
households continue to hold checking accounts of
some type, and about half of the 20 percent with-
out checking accounts maintain savings accounts
that they use because such accounts are fairly con-
venient if transactions are limited.
Still, by 1983, there was a reported decline of ten
percentage points or more in the ownership of
checking accounts among some very low income
households and households headed by persons
under 25. However, that decline could have
resulted from the adverse effects of the two reces-
sions that occurred between 1979 and 1983rather
than from rising charges. Overall, the figures show
that there does not appear to have been a decline
in the ownership of deposit accounts by the public
over the period of deregulation when charges and
fees were rising most rapidly.
Bank profitability
Did the increases in fees and charges over the
period from 1978 to the present increase the prof-
itability of personal transaction accounts at banks?
Or was the trade-off such that banks used higher
fees and charges to increase service income and
reduce unprofitable volume in an effortto offset
the higher interest costs associated with attracting
deposits directly? The Federal Reserve's annual
Functional Cost Analysis (FCA) surveys provide no
evidence that the profitability of transaction
account services has risen under the combined
effects of higher interest payments and higher fees
and charges. Instead, FCA data indicate that, had
there not been an offsetting increase in fee and
service income, the increase in the explicit interest
cost of attracting transaction balances caused by
deregulation would have led to a decline in the
profitability of transaction accounts. Thus, at least
for the sample of banks in the FCA survey, these
combined effects ofderegulation did not appear to
increase the profitability of providing checking
services.
Conclusion
Since deregulation, there has been a significant
change in how banks price their depositservices.
This change, in turn, has led to some confusion and
concern abouthow explicit pricing would affect
the affordability of banking services.
While there is now some confusion about why ser-
vice charges have risen and some concernabout
how they should be disclosed, the transition to
more explicit pricing does not appear to have
caused a reduction in the overall percentage of
households usingchecking or other liquid accounts
at banks. Moreover, more than half ofall deposi-
tors at banks continue to hold sufficiently large bal-
ances to avoid most service charges or fees.
While consumers now may have to pay directly for
the deposit servicesthey use - a practice that
promotes the efficient use of those services -
they are, on thewhole, benefiting from deregula-
tion. Deposits are paying more interest; a larger
numberof institutions are supplying banking ser-
vices; and there is now a wider array of deposit
products. Finally,for accounts with low activity,
consumers can still find attractive alternatives in
the marketplace if they shop for them,
Gary C. Zimmerman
Opinionsexpressed in this newsletterdo not necessarily reflecUheviews of the managementofthe Federal Reserve Bank ofSan
Francisco, orofthe Board ofGovernors of the Federal Reserve System.
Editorial commentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....Freecopiesof Federal Reserve publications
can beobtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6U!450m 40~n U060JO 0POI\0U
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
10/16/85
Change
from
10/9/85
Change from 10/17/84
Dollar Percentl
Loans, Leases and Investments' 2 194,803 - 328 11,148 6.0
Loans and Leases1 6 175,769 - 300 10,668 6.4
Commercial and Industrial 50,526 - 557 111 0.2
Real estate 65,234 70 3,824 6.2
Loans to Individuals 35,910 - 13 5,620 18.5
Leases 5,392 - 13 346 6.8
U.S. Treasury and Agency Securities2 11,786 - 37 161 1.3
Other Securities2 7,248 9 319 4.6
Total Deposits 204,087 4,478 13,803 7.2
Demand Deposits 51,834 4,659 7,437 16.7
Demand Deposits Adjusted3 30,630 - 2,151 1,488 5.1
OtherTransaction Balances4 14,159 - 61 1,843 14.9
Total Non-Transaction Balances6 138,094 - 120 4,522 3.3
MoneyMarket Deposit
Accounts-Total 45,433 131 7,372 19.3
Time Deposits inAmounts of
$100,000 or more 38,387 - 183 - 2,935 - 7.1
Other Liabilities for Borrowed MoneyS 22,793 264 4,004 21.3
Two WeekAverages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+J/Deficiency(-J
Borrowings
Netfree reserves (+J/Net borrowed(-)
Period ended
10/7/85
62
82
- 144
Period ended
9/23/85
61
39
23
, Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading accountsecurities
3 Excludes u.s. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
5 Includes borrowingvia FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percent change

Shopping pays

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Shopping pays

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