One month ago today the new debit interchange fees under the Durbin amendment became a reality for banks. This hotly debated and highly controversial new regulation slashed fees banks could charge on debit transactions nearly in half (the current cap is 24 cents, down from an average of 44 cents).
Banks have been bracing for this change and testing new strategies (including new fees) to recoup some of the lost revenue. There is a headline story every day that discusses the changes one bank is implementing or how another bank is responding to the regulation and what this all means for retailers and consumers.
Another outcome of the regulations hasn’t been covered: it will be increasingly important for banks to better assess the risk of their demand deposit account (DDA) customers because the line between a good and bad risk for DDA customers is going to be finer. Allow me to explain why.
The ideal, most profitable DDA customer writes few checks, has high debit transactions, high overdraft fees and is low risk for closed-for-cause action. Unprofitable customers may have similar behaviors, but because they do not pay their fees they are a high risk for closed-for-cause action.
Before debit interchange fees were capped and banks could charge overdraft fees on debit transactions (without customers needing to opt in for the service), banks profits on good accounts were so much higher they balanced out the accounts that went bad.
Overdraft and interchange fees provided a way to pad against risk. The line between good and bad used to be much less defined, but with profits being sapped by changes to interchange and overdraft fees, banks are going to need to sharpen that line to better manage financial risk.
Banks typically fall into one of two categories. Most banks only check closed-for-cause, OFAC and fraud when opening a DDA. A smaller number check traditional credit bureau or alternative data to better understand credit and institutional risk.
Today, the latter institutions have a significant advantage in managing risks to their profitability. Additionally, for banks that haven’t discovered updating risk models with a much higher frequency is vital to their business—now is the time. They will need to use a more sophisticated decisioning process that includes advanced analytics and new data sources to more sharply define where the line is going to be drawn when approving customers for DDA opening.
Banks that can better assess risk and the likelihood of an account being closed-for-cause will benefit from reduced risk and expense. A more comprehensive risk assessment is imperative if banks want to stabilize their shrinking profit margins without putting too much of the burden on their customers.
Bank of America has come under fire recently for its announcement to charge some customers a $5 monthly fee when they use their debit card. Even though many of the largest financial institutions have already started charging monthly fees for debit card use, it is too early to tell whether those fees will bring profitability back to debit or if they will simply push consumers to use cash, credit, prepaid debit cards or take their business to banks that don’t charge debit fees.
More fees are not the only answer and are likely not the best answer. It will take a combination of strategies to bring back profitability. Marketing prepaid cards that carry higher interchange fees and lower legal requirements is one option. Streamlining decisioning processes so banks can approve more accounts, reduce fraud losses and decrease data acquisition costs is another.
Regardless of how consumers respond as the debit card debacle unfolds, the banks that avoid too much risk are going to be more profitable and better protected. The banks that place an emphasis on a broader strategy to address regulation impacts rather than simply adding fees to their products will also come out ahead with their customers.
Eric Lindeen is the marketing director at Zoot Enterprises.
