Why B of A Needs $5

Is Bank of America Corp. charging for debit cards because it is shortsighted or because it is too bloated to compete against smaller institutions for consumer accounts?

The question framing is admittedly harsh, but it's hard to see an alternative explanation.

The stresses on Bank of America are felt across the industry: restrictions on interchange fees guarantee that debit card revenue will undergo a multi-year plunge, and restrictions on overdraft fees have diminished the profitability of checking accounts connected to the product. But while Wells Fargo & Co is testing out a $3 monthly fee on debit cards in a few markets, Bank of America is one of the first banks, and the biggest, that felt an urgent need to directly compensate for the lost revenue by adding debit usage fees system-wide.

There's a reason that other institutions have chosen not to act. The Durbin Amendment to last year's Dodd-Frank Act will cost the banking industry more than $5 billion in annual debit interchange revenue next year, down from the 2010 peak of $18.8 billion, according to Mike Moebs of Moebs Services. But as badly as debit card revenue will be harmed by the new restrictions on the processing fees that banks can charge merchants, interchange still has a promising future.

Bank of America explained its decision on Thursday by saying the "economics of offering a debit card have changed with recent regulations." But those economics may not have changed all that much in the long haul. Based on increasing debit card market penetration and rising transaction volumes, Moebs predicts that interchange revenue will rise to a new high by 2015.

In other words, as much as banks hated Durbin, they can wait it out. Per-customer revenues will recover.

Assume that impatience didn't drive B of A's move, however, and the picture gets darker. Studies of bank economies of scale have almost uniformly concluded that large banks are far less efficient than their smaller peers. In the case of checking accounts, the gap may be particularly pronounced.

According to survey data collected by Moebs, the average checking account costs a small bank between $175 and $200 a year between direct costs and overhead. Banks with more than $5 billion in deposits must spend between $350 and $450 per account.

Assuming that Bank of America falls into that higher range, it would be easy to see how it could go hungry on retail accounts capable of sustaining a herd of smaller institutions.

For a bank that boasts the largest consumer franchise in the country, this is an ominous prospect. But should it also happen to be reality, Bank of America's indirect move to rid itself of some customers would be the best option.

"I think this is going to cost them a million accounts," Moebs says.

Those accounts may be the ones that B of A no longer wants. Moebs notes that many of the customers who balk at $5 monthly debit card charges will be among the less profitable even after debit card revenues recover.

"If it's the case that [Bank of America is] beyond their economy of scale and can't make money on the bottom rung of accounts, then that is smart pricing," he says.