Banks shun Business with 30 million Americans

CNBC reported that banks are refusing to do business with approx. 30milion consumers in America. These consumers account for approximately ¼ of American households with combined annual earnings of $1.3trillion. The reasons for this, the banks say, is because these consumers are not profitable.

Congress passed new legislation in 2010 which gave bank customers protection from banks adopting predatory banking practices. Banks have recently been criticized recently for charging excessive fees in an attempt to generate more profits. The “Durbin Amendment and Regulation E” are aimed at limiting the profits banks can make from charging substantially high fees on debit card transactions and exorbitant overdraft fees.

Banks make money on the funds customers deposit at the bank, by loaning the funds on deposit out and charging interest. The interest charged by loaning the funds is always greater than the interest the banks will pay customers for making the deposits.

For Example:

Sam deposits $10,000 in Bank A. In the current market, Bank A will take the funds and loan it out at approx. 5%. The bank will only pay Sam approx. 0.4% for depositing the $10,000. This way banks are always guaranteed to make a profit. This example will also be true if Sam deposited only $100.

So why would the banks decline an opportunity to make roughly 5% on $1.3 trillion? The answer is quite simple. The banks can only make money on the $1.3 trillion if the banks can loan that money out, but, if there is no one willing to borrow or if people are reluctant to borrow then the banks will be stuck with the $1.3 trillion and will have to pay the depositors approx. 0.4% (or the current market rates) out of its own pocket. In the current economic climate, consumer are deleveraging (cutting back on borrowing) which means there is very little opportunity for banks to make money by loaning.   The introduction of the “Durbin amendment and Regulation E” has diminished the only source (charging excessively on debit card transactions and overdraft fees) for banks to make money on low income customers, albeit a predatory practice.

Who is Likely to Benefit?

Big retailers for the last several years have introduced financial services that specifically target low income customers. American stores like Wal-Mart and Best Buy offer financial services such as store cards, cashing checks and offering pre-paid debit cards.

Is This Really the Cheaper Option?

According to the CNBC report, Wal-Mart charges $3 to cash a check of $300 to $1000 and charges various fees for its Wal-Mart “MoneyCard”. Most average street-corner check cashiers charge between 2% and 4%. In this comparison, Wal-Mart would seem cheaper, however, according to CNBC, If that same customer cashed two $500 checks, used an ATM (using the MoneyCard) twice and reloaded MoneyCard once, the customer would incur charges of $16, “far more than the mainstream checking accounts” in America.

This leaves the approx. 30million customers in a dire predicament where they will be left with no choice but to avoid banking and financial institutions all together, and resort to saving using non-conventional methods (i.e under the mattress). The low income consumers going forward will be squeezed and marginalised even so increasingly.

This will be detrimental for the U.S economy as a whole as this will mean that approx. $1.3 trillion will be at risk of being sucked out of already fragile and struggling economy.

Who will Replace the Big Bank?

Credit Unions could stand to benefit substantially from the changes in regulation. Credit unions are not-for-profit, which means profits are funnelled back to members in the form of cheaper interest rates and fees. Credit Unions are member owned and still preserve that classical banking practices of having a one-to-one relationship with customers.

The critical point to note here is “not-for-profit” meaning that credit unions don’t have to resort to banking tricks in an attempt to generate big profits and bonuses. Credit unions are also generally fiscally more conservative, this was a major factor in helping these institutions escape the financial and economic collapse of 2007/ 2008.

A 2009 Federal Deposit Insurance Corp (FDIC) survey highlighted that of the 30 million low income consumers/ households, 9 million of them did not bank, i.e. “under banked”. Collectively these consumers spend approx. $5 billion paying off predatory loans. The 2009 FDIC survey also concluded that nearly a 1/3 of African-American and a ¼ of Hispanic households were “under banked”.

In conclusion, the government, big banks, retailers and credit unions need to come together to find an effective long term solution to these problems.

If almost 25% of U.S. households fall under this category, this cannot be a healthy sign for future economic prosperity as it would heavily dent US prospects competing Chinese and other rising economies.

Sources/References:

http://www.cnbc.com/id/45899309