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Industry Opinion
Banks Keep Trying to Maximize Fee-based Income
By Nironjan Roy, CPA, CMA — Certified Anti-money laundering Specialist and Banker
Once, people kept money with banks by opening an account and, in exchange, receiving banking services. Initially, most services were free, meaning they were part of the account contract. Now, those days are gone, as banks have introduced fees for almost every service.
Customers
Customers pay for many monthly account transactions. A debit card is the customer’s bank ID, but merchants charge fees indirectly for every purchase the customer makes with a debit card. Even investing money through a bank account, trading shares through a bank account, using a credit card, and receiving funds from banks are subject to certain fees.
The banking industry
Worldwide, banks in both developed and developing countries have broadened their revenue sources across multiple areas, including interest-bearing business and fee-based services, rather than relying on a single interest-earning scope. Banks now focus more on fee-based business than interest-bearing lending. In this context, U.S. banks have long led the way in diversifying their revenue-earning avenues. However, they are now taking a strategic approach to maximizing revenue from fee-based products. Some large U.S. banks have engaged in a collective effort to acquire a service-providing company so it can use its facilities to maximize fee-based income. In the U.S., banks cannot charge fees as they wish because a law limits the fees banks earn on customers’ debit card use. Also, when providing card-based services, an intermediary company gets involved because banks use its infrastructure to process payments, keeping capital expenditure to a minimum.
A few years ago
A few years ago, Capital One bought “Digital Financial” for $50.6 billion, giving it an established network to avoid third-party intermediary services in card transactions. Because of this network, Capital One can deal directly with its customers, increasing its fee-based income. Part of the fee the middleman usually takes also goes to the bank’s earnings, and the cap on fees for debit card transactions does not apply when there is no third-party involvement. Capital One’s move has opened the scope for many large banks. Some big banks, including JP Morgan Chase, Bank of America, Wells Fargo, and PNC Financial Services Group, are now trying to own a service-providing company so they can avoid third-party service charges and the legal requirement to cap them.
Media Reports
As learned from media reports, these banks have already made good headway towards acquiring a company, “Fiserv”, which is a financial technology company engaged in providing network services. Fiserv plays a bridging role between industry players and merchants; the former includes banks and financial institutions offering debit-card facilities, while the latter includes merchants that sell goods and services in exchange for accepting payment through debit cards. Fiserv owns two financial networks, STAR and Accel, which provide network facilities for processing debit-card transactions. Media reports say Fiserv has struggled with a drastic fall in its share price, which has dropped 70% from a year ago, creating an opportunity for some big banks that are considering acquiring the company.
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The media also reports that, under a section of the Dodd-Frank Act passed in 2010 immediately after the financial meltdown caused by the subprime mortgage crisis, a cap is placed on certain fees large banks collect from merchants on debit-card transactions routed through an outside network. Alternatively, banks can avoid this cap if they own the network, known as the infrastructure required to process transactions. It is worth mentioning that fees charged on debit-card transactions amount to billions of dollars every year across the industry, but the banking sector, mostly large banks in the U.S., has been complaining that their revenue from fee-based business has been limited due to this act.
Interchange Fees
These fees, commonly known as interchange fees, are payable by merchants to the banks and financial institutions that issue debit cards when they accept debit card payments. The Dodd-Frank Act gives the Federal Reserve the authority to set caps for banks and financial institutions with assets of $10 billion or more. Banks oppose this cap on fees, arguing that a portion of debit-card fees helps them recover costs associated with free checking accounts and debit-card rewards programs that attract customers to banking services.
Against these interchange fees, the counterargument is that merchants do not pay them out of pocket; instead, they build them into the price of goods and services and pass them on to customers, which can contribute to price hikes. However, banks’ move to avoid a cap on interchange fees by sidestepping legal requirements through a strategic approach of owning network facilities may not be easy, as it may lead to a tussle with the government and regulators, who may come up with another legal weapon.
Since banks have already reaped benefits from fee-based income with minimal or no risk, they will not only try to maintain it but also maximize revenue from this source. Whatever the regulatory requirements or restrictions, they will find a way to bypass them or use a loophole to keep fee-based income rising.
Banks’ recent attempt to collectively acquire the company providing the infrastructure required to process payments suggests they will keep trying to maximize fee-based income, so customers should be mentally ready to keep paying for whatever services they receive from banks.
