RevenueLoan Blog

June 10, 2011

Why Banks Suck Part 1: Overdraft Fees

Filed under: Uncategorized — rsbelcher @ 5:57 pm

Financial intermediaries, like banks, exist because of a market need. Pure economics. Someone a long time ago, saw a need in the marketplace for a financial intermediary, hung a shingle, and began the first savings and loan institution.

The market need that a bank fills is two-fold: to reduce information costs and to reduce transaction costs.

A bank reduces information costs by:
– reducing the search cost by bringing borrowers and savers together,
– conducting independent valuations to reduce adverse selection (aka price discovery), and
– monitoring

A bank reduces transaction costs by:
– providing denomination intermediation ( apparently doesn’t),
– providing maturity intermediation,
– providing a payments system
– diversifying risk
– hedging risk
– providing liquidity

By providing these services, banks lower the interest rate that borrowers pay and raise the interest rate that savers make. The bank makes money by setting these two rates slightly apart, thus “banking” the spread[1].

Now please tell me, where on that list is: “Charge usurious fees”?
*******
We here at RevenueLoan work with small businesses who are all kind enough to show us their dirty laundry, giving us access to their bank statements. I am floored by the frequency (sometimes every couple of days!) and high cost ($75, $135 even $175!) of bank overdraft fees.

It is well documented that over the last 30 years Wall St has lured the best and brightest away from Main St by paying them huge bonuses for inventing new ways to charge fees to savers and borrowers and to increase the velocity of transactions to almost continuous.

Instead of workers innovating in the fields of medicine, education, manufacturing, design or engineering, our society has rewarded them for strangling those very industries they should be working for by adding complexity on top of an industry that at its foundation is a very simple one. The saying is about brain surgery and rocket science, not banking.
RevenueLoan is different. Wall Street got greedy and over-levered the country into the worst credit crisis we have every experienced.

We want to repower America’s small businesses and offer them credit. We want to do it a different way. Without all the fees.
*******
For more information on financial markets in theory and in practice, RevenueLoan, why banks suck, and denomination intermediation (just fun to say), feel free to contact me.
Rob Belcher
303-870-9529
rbelcher@revenueloan.com

[1] Dr. Alan Hess. “Effects of Information and Transaction Costs on a Financial Market”. 2000.

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4 Comments »

  1. Rob, aren’t there ways around these fees? Like keeping some set (probably obscene) min in the account? Just curious if the business banking is similar to the personal banking world…

    Comment by brittanydt — June 12, 2011 @ 10:25 pm | Reply

    • Absolutely. Obviously, a cash flush business will likely not incur these fees. However, for fast growing, successful businesses, it is the lack of flexibility or help … or even more important, lack of customer service that banks provide to businesses that inspired this post.

      1. Small to medium sized businesses don’t have a treasury department, they may not even have a bookkeeper/accounting person to manage cash and keep track of the timing of deposits and withdrawals. When they are growing quickly, they especially don’t have time to step back and manage cash. They are doing everything they can to sell new business, and produce to fulfill previous sales. When they are in this cycle, managing ARs / APs and cash falls in priority.
      2. On the more vindictive and predatory end of the spectrum, I have even heard rumors – just rumors mind you with no data or source – that banks prioritize withdrawals, while it may drag its feet processing a deposit. If an account’s average balance is relatively low, or if the deposits and withdrawals are large and lumpy, then this increases the likelihood of an overdraft.

      In our mind, banks should offer overdraft protection “credit lines”, covering overdraft shortfalls and charging interest until the balance is restored. I would guess the fees or more profitable (more revenue, and less cost to administer).

      Stay tuned for what RevenueLoan plans to do about overdraft fees.

      Comment by rsbelcher — June 13, 2011 @ 9:44 am | Reply

  2. What if banks weren’t in the business of collecting overdraft fees? Instead, a system exists in which the only people who don’t overdraw their accounts (free borrowing) are those who do so simply by choice [2]. Milton Friedman (by extension of principle).

    I mean, isn’t this why line of credits were created? Borrowing isn’t free. Just like your utility bill, by turning the heat on (over drawing your account), you creat a cost that is tied to the consumption a good, the burden of which must ultimately be burdened someone–the bank or the borrower. As a small business owner w/o a cash manager…after how many $175 overdraft fees do u decide it’s worth paying for short term cheap credit?

    Comment by Keith — June 17, 2011 @ 11:03 pm | Reply

    • Keith, my personal beef with the overdraft situation is not with the existence of overdraft lending, but with the deceitful and intuitively inequitable way that it’s implemented as a fee-based, rather than interest-based, system (even after the feds brought a gun to the knife-fight and forced the big banks to stop the most egregious of practices).

      The fact is clear: an overdraft facility IS a line of credit. The bank provides it only subject to its credit standards. Yet, instead of charging a rational (even punitive) rate of interest and stating the size of the overdraft facility, the bank treats it as a fee machine and extracts the maximum revenue possible, based upon rules that it sets and that bear no relation to the actual size of the credit facility or implied risk thereof.

      There IS an alternative. ING Direct offers consumer depositors a no-fee overdraft line of credit. If a customer happens to overdraw an account, he simply draws on this line and starts paying a reasonable, if high, rate of interest (I think right now it’s ~ 10% APR). ING still makes a credit determination (just like an overdraft-shark bank); they still make the funds available conditionally on that determination (just like an overdraft-shark bank); and they still make a profit that compensates them for the higher risk and the on-demand availability. However, rather than making a $75 fee on a $19.99 overdraft, the consumer pays 10% (or whatever) annualized and gets a pleasant email. Hell, a bank could charge 100% annualized interest as a penalty rate for overdraft, and it would still be light-years better for entrepreneurs and consumers.

      There’s simply no defense for the current regime of overdraft fees. It’s a rent charged by banks just because they can.

      What’s the answer? Probably not more regulation (at least for businesses and sophisticated consumers). ING is proving that banks CAN use superior service and policies as a differentiator — there are certainly other such innovators that I know less well. Spread the word and vote with your pocketbook.

      Also … if you’re a business, maybe consider getting a nice big slug of working capital from RevenueLoan to use as a buffer and to help grow you past the cash management growing pains 😉

      (P.S. … don’t give me that behavioral finance shit about how it’s meant to change peoples’ behavior. That might have some basis in reality IF the excess rent from the $75 fee (say, $74.90 of it) went to a third party, charity or such. But since the bank gets the fee as nearly all contribution margin, the bank doesn’t want to change people’s behavior. It would be as if you said “let’s try to cut down on smoking by raising the price of cigarettes … Altria et al., please jack up your prices and keep all the increase.” They’d pocket the extra dough, all right, but they wouldn’t exactly be committed to encouraging healthy lungs because of it.)

      Comment by rlucas — June 20, 2011 @ 7:49 am | Reply


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