Bankers and regulators are about to reinvent "free" checking.

Several banking companies' decision to adjust their overdraft fee policies, along with an expected Federal Reserve ruling affecting other vital fee structures, threaten to alter the ubiquitous product.

The changes will come with a cost. Free checking has helped banks gather cheap deposits while supplying a hearty dose of fee revenue for items ranging from nonsufficient funds to automated teller machine transactions. Though free checking is likely to remain an offering, observers believe regulation will significantly transform the product.

"I think there is going to be a steeplechase" among banks looking to retool free checking, said Hank Israel, the director of payments and checking at Novantas LLC. "Free isn't going to go away totally," he said, "but I think it will become a damaged item. Banks will have to tout it as free, but … ."

Banks are facing external pressure to change the fee structure built around free checking, which was a useful tool during the past decade to bring in the unbanked. Senate Banking Committee Chairman Chris Dodd introduced sweeping legislation this month to curb overdraft fees.

The Federal Reserve is expected to issue a final ruling on overdraft fees in the next two months that could also tighten oversight of ATM fees and charges associated with one-time debit card overdrafts, all of which play key roles in banks' noninterest income.

Kevin Jacques, the chairman of finance at Baldwin-Wallace College in Cleveland and a former Treasury Department economist, said a number of banking companies could be pinched. "We have had a number of banks that have gone further and further and become too dependent on noninterest income" as an offset to lower interest income and credit woes.

The impact of tighter oversight of Regulation E, which covers overdraft fees and other electronic funds transfers, could be substantial, bankers and observers said, though the precise severity remains unclear.

Bank of America Corp. Chief Financial Officer Joe Price said during an Oct. 16 call that internal actions to reduce overdraft fees would reduce fourth-quarter profit by $150 million to $200 million. The Fed's ruling "may further impact our fee revenue"; he promised "more explicit" commentary once the ruling is known.

Michael Cavanagh, the CFO at JPMorgan Chase & Co., said his company's retail business could lose about $500 million annually due to its decision to curb overdraft fees. "That's a pretty simple number," he said during an Oct. 14 conference call. "We don't have all of the other impacts that likely come along to say what to expect with a great degree of conviction."

Wells Fargo & Co., which also announced plans last month to reduce overdraft fees, did not detail the potential impact of its actions during its third-quarter call. The company refused to comment.

Service charges at banks rose 5.5% in the third quarter from the second, though they were down 1.1% from a year earlier, according to an analysis of call reports by Foresight Analytics LLC.

Executives at smaller banks are also watching Washington.

Robert E. Marling Jr., the CEO of Woodforest National Bank, said he is concerned the changes could negatively affect proactive banks. The Woodlands, Tex., company, for instance, has let customers opt out of overdraft protection for several years. The company has also refunded overdraft fees to roughly 36,000 customers after they took a 30-minute financial literacy class online.

Woodforest, which has a sizable in-store branch network with Wal-Mart Stores Inc., charges $2 when noncustomers use its ATMs. "We do have a dog in this fight," Marling said. He would prefer regulators who deal daily with banks to intervene, rather than legislators. "Debit card proliferation has gone wild in the last few years," he said. "I think there will be a move from punitive pricing to service pricing."

Such is the case at TCF Financial Corp., which will introduce a checking product next quarter that will replace overdraft fees on each item with a daily nonsufficient fund charge and another charge should an account fall below a certain level. One result is the return of the monthly account maintenance fee at the $17.7 billion-asset Wayzata, Minn., company. (More than one-quarter of TCF's third-quarter revenue came from banking fees and service charges.)

"This will totally restructure how our fee income works," William Cooper, TCF's chairman and CEO, said in an interview last week. Though having the potential to stabilize, or perhaps increase, revenue, he said that changing customer behavior is "the one unknown" to modeling profits.

Israel said other banks should have time to evaluate and adjust checking programs, based on his belief that any proposed change would not be enacted before December 2010 at the earliest.

Some bankers believe that would give the industry ample time to adapt in a way that would preserve some of the logic underpinning free checking. "Depending on what is brought forward, I am confident that free checking will be around for many years to come," Marling said.

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