It’s March, but it’s not too late to publish our predictions for 2011. First of all, banks usually go into hibernation for the winter months, and leave interest rates alone until springtime. Second, the 2011 game-changer is the Durbin Amendment, and when and how the Federal Reserve decides to regulate debit merchant exchange fees will have profound implications for the entire industry.
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The Fed is still reviewing its proposals, however, so the NerdWallet Ouija board keeps showing, “Try again later.” Still, we’ve put together a list of five banking industry trends that we think will accelerate or deepen in the remaining 10 months of the year.
1. The rich get richer and the poor get poorer
Rates on low interest cards have been falling for a while, and we’re seeing an uptick in balance transfer and other promotional offers. Banks are offering juicy rewards for those with good credit, in an effort to get the penalty-dodging-APR crowd spending money. For those who front the cash for annual fees, rewards credit cards are improving too – see, for example, the new deal out of Capital One for 100,000 bonus miles. This kind of deal hasn’t been seen in years.
Vitally, credit card merchant exchange fees are not regulated by the Durbin Amendment, and often bring in higher fees than debit cards. Rewards credit cards command the highest swipe fees of all, so look for banks to push customers to get rewards cards and then to use them often.
On the other hand, interest rates have spiked for those with bad credit. The Credit CARD Act of 2009 prohibited “risk-based pricing,” in which card issuers changed the interest rate of a card if the customer’s risk profile changed. They can also no longer charge overdraft fees unless customers opt-in, and even then can do so in a limited fashion.
Unable to hike interest rates and denied lucrative overdraft penalties, banks now charge a higher rate upfront. Some banks even charge a flat fee for poor credit histories, irrespective of consumer behavior and in addition to the annual fees that come standard with poor credit. No one expects interest rates to be as low as they were in the pre-recession days, but those with bad credit will be hit harder and longer.
2. More fees, less free
This is where financial reform comes in. The Dodd-Frank bill banned overdraft fees unless customers opt in, curtailed rate hikes in credit cards, and per the Durbin Amendment, authorized the Fed to limit debit interchange fees. In years past, “free” checking was paid for by “swipe fees” and by overdraft charges on small segments of the population.
Now, banks cannot earn as much money from the overdrawing crowd. The cost of free checking, which was never truly free to begin with, will be spread over a broader customer base. Rob Windsor, president of First Financial Services Credit Union, says, “Consumers are used to getting all these services for free, including free checking, debit, credit. But none of these things are free. We need revenue to pay for them.”
The revenue will come from charging for services that were previously free. Free checking is already on its way out: many banks now charge a monthly fee, or for services such as paper statements and teller assistance. Others are becoming creative with their fees: Bank of America demands a $59 annual fee for credit card customers with bad credit, while Citibank levies a fee for customers who put less than $2,400 on their cards a year.
Debit interchange fees, interest rate hikes and overdraft charges were extremely lucrative for banks. Now, they are forced to change their revenue models and spread fees over more of their customers.
3. Pruned debit rewards programs
Banks make money off different customers in different ways. Those with poor credit pay in the form of high annual fees and high interest, penalty and cash advance rates; debit cards previously yielded overdraft and swipe fees; and rewards credit cards offered juicy premiums on merchant fees and the occasional annual fee.
As we mentioned before, only the last revenue stream is still in place. Therefore, while banks spice up their rewards credit cards to get the cardholders spending and swiping, rewards debit cards are nowhere near as lucrative.
A number of banks now charge annual or monthly fees for debit rewards programs, or have removed them altogether. PNC did away with free rewards checking, and Chase and Wells Fargo have axed their entire debit rewards program for new customers. Other banks are expected to follow. Rewards checking still exists; free checking still exists. Both in the same account, however, is a feature likely to become history.
4. New toys online—and new fees offline
The financial industry is not immune to technological innovation, which offers greater and easier access to consumers. A number of banks now have mobile apps that allow users to check their balance, make transfers and even scan checks.
In the wake of the financial crisis, some are offering online financial tools to help customers make and stick to budgets, and to help students use their first credit card. Citibank will soon introduce its 2G cards, which feature a smart chip instead of a magnetic strip for security. Users can, with the touch of a button, pay for their purchases with rewards or with their credit account. Starbucks is testing a prepaid card smartphone app, and Visa and Mastercard are developing systems that require only a smartphone to pay. PayPal and startup BlingNation are testing a pilot program in Silicon Valley that does just that.
Online banking has benefits for banks as well: online statements and support documentation are far cheaper than mailed statements and salaried tellers. As a result, some checking accounts charge for paper statements and for receiving teller assistance. Still, the move to online banking is a net positive for consumers, who can access their account easily, transfer funds, and save paper. The new technology in the works is likely to be rolled out in the next couple of years; look for more developments and introductions as banking finds its way onto smartphones.
5. The rise of retail finance
Banks make their profits off financial services and pass them on to their shareholders. Credit unions make their profits off financial services and pass them back to their customers. Retailers, on the other hand, make profits when people buy their merchandise, and so make an effort to drive traffic to their stores.
In particular, retailers love in-store shopping: people are more likely to browse the shelves and make a few more impulse buys. If a retailer can use a credit card to increase sales, and spend some of its profit to lower interest rates or offer better rewards, then both the retailer and the cardholders win.
Target offers a rewards debit card—it’s one of the few remaining free rewards debit cards—that gives a 5 percent in-store discount with no annual fee. It also offers a credit card with the same rewards rate, no annual fee, and an APR that’s slightly above industry average. According to a Target spokesman, the store will keep its rewards program regardless of the Durbin Amendment outcome, since they don’t rely on a third-party payment processor for transactions.
Wal-Mart, too, began its foray into the murky waters of finance. It offers prepaid debit cards at $3 a pop, with 1 percent back on gas purchases, and $3 for check cashing services. Its prepaid debit card fees are significantly lower than those of other providers, but serve Wal-Mart’s goal of being a one-stop shop for its consumers. The company also partnered with Jackson Hewitt to provide tax services to shoppers, and acquired an equity interest in prepaid card supplier Green Dot. Sam’s Club, a Wal-Mart subsidiary, now makes small-business loans.
Other retailers have financial products that more directly benefit their sales or bring in fees. Best Buy, along with Tio Network, now has bill-paying services that cater to Hispanic customers who typically avoid traditional financial services. Kmart began a similar pilot program aimed at un- or under-banked shoppers who lack or do not use checking and savings accounts. Last year, Kmart and Sears dusted off their Layaway Programs, in which the store holds an item while customers pay the cost over 8 weeks for a small fee. Many other retailers offer “Christmas savings accounts,” which yield savings of 0 percent to 3 percent and can only be spent in-store after a certain date.
The companies mentioned above are already expanding their services or piloting new ones, while others experiment with bill paying and rewards programs. In 2011, more retailers who serve low-income households with a limited credit history, and retailers who make their profits on the volume of their transactions, are sure to join these frontrunners.
Tim Chen is head nerd at NerdWallet.com, a site dedicated to helping consumer understand credit card offers.