For banks, free checking is many things — but it isn't free.
Despite a public perception that taking deposits is a can't-lose business, maintaining a checking account costs banks between $250 to $450 a year. In many cases those accounts aren't even turning a profit.
The average checking account cost banks $349 in 2011, says Mike Moebs of Moebs Services Inc, a research firm. But the average revenue per account is just $268, implying a loss of $81.
That equation helps explain the thinking behind some of the recent, highly-controversial steps banks have taken to raise the prices their customers pay for checking accounts.
"Banking is a subsidized business," says Hank Israel, a partner at New York-based consulting firm Novantas LLC, pointing to the fact that the profitable accounts balance out those accounts maintained at a loss. "When the plane flies full, coach covers the whole cost and first class is the profit," Israel says.
But thanks to new regulations, including the Durbin amendment in the Dodd-Frank Act, which caps fees on debit interchange, the number of profitable customers is falling. Those fee caps, which went into effect on Oct. 1, are expected to eliminate more than $5 billion in annual bank revenues.
"Since Durbin, the coach class isn't breaking even, so the profit [on checking accounts] is being cross-subsidized by [deposit] balances, and with interest rates so low that's not covering costs either," Israel says.
He estimates that one third to one half of checking account customers are now unprofitable for banks.
The single biggest cost, Israel says, is the cost of bank branches and ATMs. Another 20% is spent on back-office functions, including maintaining call centers and payment operations.
Overhead costs, including executive salaries along with security and compliance expenses, also account for about 20% of the costs. The last 10% covers product development and sales.
The mismatch between the costs and the returns of checking accounts is untenable for the industry at large. But as banks consider what the new regulatory landscape means for their account offerings, analysts caution that the solution is not likely to be one-size-fits-all.
This is in part because the costs to maintain checking accounts can vary widely across institutions of various sizes.
For the largest banks with assets greater than $50 billion, the average checking account costs between $350 and $450 a year, according to Moebs. Overhead, or the institutional costs not associated with a specific division or service, is what weighs down some of the largest banks, making it more difficult to cut costs, he says.
But he adds that for some of the smaller banks with less than $5 billion in assets, the costs are much lower — around $175 to $250 a year.
The sweet spot for breaking even or squeezing out a profit on free checking is likely to be among the mid-sized institutions.
The issue comes down to efficiency and economies of scale. The banks likely to fare best are those that are big enough to support a sizeable base of checking account customers, but which are not loaded down with ancillary costs.
"The community banks and the credit unions will offer free checking and will get revenue — the major item is from overdrafts — and that revenue and other revenue, such as transaction revenue, it's enough for them to break even," says Moebs.