For many financial institutions and their customers, the consumer banking system has been mutually self-destructive.
The imprudent extension of mortgage credit and purchase of consumer credit are causing millions of home foreclosures, millions of consumer insolvencies, dozens of institutional insolvencies and many more threatened institutional insolvencies prevented only by extraordinary government interventions.
At the same time, the imposition of more and higher fees by financial institutions is costing consumers tens of billions of dollars annually and has contributed in a big way to a situation in which millions of consumers with the lowest and least secure incomes are refusing or unable to participate in the traditional banking system.
Federal legislators and regulators have taken steps to check some of these practices. In 2007, Congress passed legislation restricting consumer loan rates charged military personnel to 36%, thus effectively ending payday loan sales to servicemen and servicewomen. In the past year, first the Fed then Congress approved significant new consumer credit card protections. The Fed issued new mortgage loan disclosure rules recently, and Congress is considering related protections.
Moreover, to help ensure that federal bank regulators adequately weigh consumer interests, the Obama administration has urged Congress to establish an independent Consumer Financial Protection Agency.
All these interventions are appropriate and necessary, but they are limited in that they seek mainly to protect consumers from bad practices rather than promote good ones.
More fundamentally, the interventions largely fail to create a virtuous cycle where positive institutional and individual behaviors reinforce one another.
In a virtuous system, the principal goal of financial institutions would be to help consumers manage their finances and build wealth. As consumers accumulated savings, they would become more financially secure and better credit risks. It would be easier for them to afford mortgage down payments — now 3.5% of loan principal on FHA loans and at least 10% on most non-FHA loans — and to qualify for lower mortgage interest rates. Better able to meet financial emergencies, Americans would be more willing to save for retirement.
A key feature of virtuous banking would be automatic saving — regular electronic transfers from checking to saving and investments. As employees who build retirement savings through payroll deductions know, the only effective way for most people to save is through regular, automatic deposits. Particularly for their lower-income and their younger customers, banks and credit unions should urge every checking customer to also open an autosaves account. If these institutions made such an effort, the proportion of low- and moderate-income households with a savings account would likely increase from its current level of only 40%. After these customers built adequate emergency savings, they should be offered and encouraged to purchase higher-yielding accounts that included incremental certificates of deposit to which regular automatic deposits could be made.
In conversations with top savings officials at many banks and credit unions, I have found much interest, even some enthusiasm, for promoting automatic saving. These officials understand that this saving provides low-cost capital that could increase exponentially over time, develops a growing internal market for low-risk consumer and mortgage lending, increases customer loyalty and helps rebuild their tattered reputations.
What initiatives would best foster more virtuous consumer banking? I keep hoping that one of the biggest banks will recognize that visibly and effectively helping their customers build wealth, and exercising restraint on fees, would give them a considerable competitive advantage. But it is also essential that the financial services regulators — now preoccupied with issues of lender and borrower insolvency — encourage and, when necessary, require institutions to act more virtuously, and that credible financial leaders encourage consumers to do the same. In the long run consumers, banks and the whole society would greatly benefit.