Stop Shrieking about Durbin and CFPB, Start Planning Instead

The majority view is that derivatives have been very helpful to financial institutions in mitigating serious risks. If so, why is it that the class of banks most active with derivatives, namely the systemically important banks, showed the greatest propensity to fail during the recent crisis?

The answer, at least in part, is that the most dangerous risks incurred by banks can't be hedged by derivatives — and banks have done a poor job of recognizing, much less mitigating, these externally generated exposures.

One such hazard is posed by the Durbin amendment — widely denounced as creating a dreadful, huge financial risk for banks. What have banks done to reduce their exposure to this risk? After all, the amendment was passed more than a year ago. There has been more than enough time to hedge the consequences of its actually becoming effective.

The obvious way to do this is to rethink your retail product portfolio — deposit accounts and payment vehicles such as debit and credit cards — to see how it could be modified to accommodate a changed revenue environment. For instance, issue credit cards to replace debit cards.

You can see that banks haven't been doing that. Instead, three kinds of responses have predominated. One was, "We have a great lobbying program." In other words, let's hope this nuisance goes away — and spend some money to help it do so. Put Sen. Tester to the test. But this doesn't reduce the risk to anywhere near zero. You still need a prepared response to an undesired outcome, or better yet a program to turn lemons into lemonade.

The second reaction was, "We're waiting to see how this comes out." I have absolute faith in the sincerity of the many bankers who told me this month after month. Look at what they did, or rather, at what they failed to do. Was that a strategy? Can it possibly be the best strategy?

There's lots of other evidence that many bankers don't much like making contingency plans!

No wonder, then, that analysts and investors now see banking as seriously risky, and that stock valuations are low. The more shrieks we hear about how banks will be killed by Durbin, interest on business checking, the Volcker Rule or some other monster, the more we can expect investors to shun bank stocks. They won't buy into Crybaby Banking.

This is exacerbated by the third bank response to Durbin, typified by one large institution that announced cutbacks in debit card incentives and rewards — accompanied by frantic political hand-waving. Maybe that even inspired a few customers to uselessly write their representatives in Congress. Shortly after, the chief executive said that retail had a terrible quarter. One thing, the knee-jerk, seems to have led to the other.

We're now witnessing a similarly dysfunctional combination of heads-in-the-sand with politics-as-usual, as banks for the first time face the certainty of having to cope very soon with an unfriendly regulator, the Consumer Financial Protection Bureau.

Up to now, perhaps the biggest differentiator between banks and their nonbank competitors is that only the nonbanks have had unfriendly regulators. Now we have a more level playing field.

Banks should scan their retail products, pricing, marketing and servicing activities to see where the first blows are likely to fall — and to reduce vulnerabilities. Heed the signals: statements from CFPB officials; prior but unconsummated regulatory proposals; volumes and trends in complaints and consumer litigation.

Overdrafts are a spectacular example. Late fees and over-limit fees have been curtailed. Aren't other penalty fees going to be reduced also? Voluntarily limiting daily overdraft fees to $240 and changing the order of debits likely will not be enough to placate the CFPB. Credit protection and other protection services are a second conspicuous example, which I dealt with in more detail in a recent column.

No crystal ball is needed to see that any provisions of account agreements or transaction terms that generate incremental revenues wildly in excess of incremental costs or are poorly understood by consumers will head the list for repressive action, and possibly for forced disgorgement of prior profits.

Which revenues are the most vulnerable?

Someone in your organization had better figure that out — and develop action alternatives.

More important, see how you can get ahead of the trend and preemptively, proactively adapt your products and pricing so that they deliver greater perceived value more profitably and with less exposure to accusations of unfairness.

This isn't going to be achieved just by charging $9 a month for checking accounts under $1,500 — that is, by going back 20 or 30 years into the past.

There are economic and credit cycles, but technology and payment vehicles only move forward. Banks must also move ahead, or else be left behind. It's harder to move forward when you are jumping up and down and screaming.