Going Public with Costs Is Dangerous
A disturbing trend in banking has been the growing number of institutions that pay interest on only 90% or 95% of a consumer's balance.
The reason banks offer for this practice is that they have to set aside funds for reserves and Federal Deposit Insurance Corp. assessments.
Granted, banks must meet these costly requirements. Granted, banks therefore cannot earn interest on the portion of deposits that goes into reserves and FDIC assessments. Still, telling this to customers is poor policy.
What's the problem? Costs should not be explained to customers. Banks should have a price for services and an interest rate paid on balances -- and this means the entire balance. To provide a finer breakdown is courting danger.
A Forgotten Lesson
I thought banks had learned this lesson three decades ago.
Up to that time, most banks offered services at cost and earned a return by seriously undercrediting balances. Most banks gave about a tenth of a percent per month in earnings credit.
The result was that many customers used the services and paid with fees while keeping their balances in money market instruments that offered a lot more than the 1.2% a year.
Many banks thus learned that if they want corporate balances they must give a competitive return and must price services, not offer them at cost.
But obviously, the lesson was not fully learned.
Even today, a great many banks give corporate balances a 15% to 20% haircut before determining earnings credit.
Discouraging Deposits
The reason, again, the banks say, is the since they must maintain reserve requirements, they can use only about 90% of a balance.
To be sure, many banks get away with it. But many acute treasurers simply look at that haircut and say: "Why should we leave balances in the bank subject to the haircut when we can invest our funds and get interest on 100% of the deposit? We will pay the bank with fees instead, and save the haircut."
To me, though, there is a the far more serious issue: By clipping 10% off the balance before figuring earnings credit, the bank penalizes the depositor and uses the penalty income for someone else.
If the bank didn't want to make loans, it wouldn't need the deposits. By utilizing the haircut, the bank penalizes the provider of the funds to benefit the borrower.
In all fairness, the borrower should pay the cost of reserve requirements and FDIC assessments, not the depositor.
This is especially so since the depositor has the alternative of taking his money elsewhere and compensating the bank for services with fees.
Revealing Too Much
But just as serious is the practice of spelling out to customers the bank's costs and giving reasons why the bank cannot provide full value in interest on deposited funds.
There is the story of the major Chicago bank that was having a new building constructed. One day, the bank's chief financial officer called the manufacturer of the elevator system and asked the president, "What is it going to cost you to build and install the elevators in our building?"
"What business is it of yours," the manufacturer replied. "We are giving you a price, and that's what you have to pay."
"Aha!" said the banker. "If you won't give us your costs, why does your treasurer ask our costs for help in deciding what you are willing to pay for our services?"
"You weren't stupid enough to tell our treasurer your costs, were you?" the elevator company chief replied.
A Can of Worms
This is the issue.
Once a bank starts reporting costs and why it's charging what it charges and deducting what it deducts, the customers will be asking for more and more breakdowns. The bank winds up with less and less privacy to determine what it will charge and where it will make its profits.
Already, Rep. Esteban Torres, D-Calif., has introduced a bill that, among other things, would force banks to pay the stated savings rate on the customer's full deposit every day. The bill would also require banks to figure the annual yield on savings in a uniform way so the public can compare one bank's actual rate with another's.
And we all know that once Congress starts debating a "truth in savings" bill, we will have no assurances as to what other conditions might be imposed.
In banking as in any other industry, costs should remain the seller's business. It is dangerous for banks to spill their guts to customers, even when times are tough.
Whether the money goes into assessments or salaries or never comes in, because of reserve requirements, is nobody's business but the bank's.
Mr. Paul S. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.
