Banks are continuing to tick people off. Lately, the complaints have centered on two things: the monthly fees that some banks are planning to charge for using the debit cards they were so anxious to give everyone and the recent stories that some banks are charging fees to allow people to deposit money.
The New York Times had a story on Monday ( “In Cautious Times,Banks Flooded With Cash”) that was accurate but somewhat misleading. The story highlighted the one instance where a bank talked about the possibility of assessing a fee for deposits, but failed to explain that it was a one-off and why it was a one-off. The article then went on to talk with some bankers who said that it is a difficult time to execute the traditional banking model - which it is,but which is a separate issue from charging fees for deposits.
So let’s take a step back and talk about that traditional banking model. In its simplest form, banking is taking in deposits and using that money to make loans. If anyone needs a refresher,the holidays are coming,so an advanced screening of “It’s a Wonderful Life”would not be out of order. That movie portrays a basic example of a bank that funds itself through deposits.
Simple enough, but a bank can’t just take in a deposit and then make a loan of the same amount. The Fed requires that some percentage of most deposits be reserved, so the banks can’t really do anything with that money. These are the “Required Reserves”that banks hold at the Fed.
Additionally, banks must pay a small percentage of the money for FDIC insurance - you know,in case they go bankrupt. This is a fixed and small percentage,but it does have to be paid. More on this soon.
The bank is then free to lend out or re-invest the rest of that money. In general, banks would prefer to lend against this money rather than invest since the interest rate that they can make on a loan far exceeds what they could get by investing it short-term. And banks do invest this money short-term because people can come in and demand their money whenever they want it.
So, in normal times, banks like deposits because they can pay a low rate to the depositor and then make more money off a loan. The difference between what they pay the depositor and what they earn on the loan is a simplified version of Net Interest Margin (NIM) or “the spread”(not to be confused with “the vig”). Banks try to maximize the spread by paying lower rates on deposits and charging higher rates on loans - and competition sets outer limits for both of those values.
But,as we all know, these are not normal times - and that is causing the banks quite a few headaches.
Prior to the financial crisis, bank lending standards became pretty lax. The reasons why are beyond the scope of this post, but the sheer scope and scale of the laxity was mind-blowing. There are a few consequences of that laxity. First, banks had to write off a number of loans and are still carrying many others that aren’t doing so well. When they write off loans or reserve for loans that they think will go bad in the future, they eat into their equity, their capital base. And banks need a certain amount of capital to continue in business.
The second result of the crisis is that banks had such mind-blowing laxity that regulators were forced to make them tighten their lending standards and raise large amounts of equity –not only to replace what was lost, but to add to it in a signficant way.
Flash forward to today. The banks are recovering but they still need to add to their capital bases to comply with the new standards from Basel III and Dodd-Frank. They would like to make more loans, but only to the people and companies that have strong credit –and those people and companies aren’t looking for loans - they’re stashing cash on their own balance sheets.
To make matters worse, the low-interest rate environment means that the banks’spread, or NIM is shrinking,even on deposits. Back in 2005, a very good rate on a bank account was about 0.75% while the 2-year Treasury was hovering around 4.0% –meaning that, even if banks didn’t have a loan they wanted to make, they could earn over 3% on your money. Not bad. They also didn’t blink at paying that FDIC charge for deposit insurance.
With the 2-year Treasury at 0.24%,however,the environment has changed. Banks might only pay customers 0.03%, but they’re only making 0.21%. And did I mention that the FDIC charge is a fixed charge? It varies,depending on the bank, but it doesn’t vary depending on the market. An average FDIC assessment is about 10 bps., or 0.1%. Suddenly, banks are only making 0.11% on your money - and that’s before you figure in the overhead costs of cashing checks, mailing statements,etc.
After the financial crisis, there was also a change in the way that the FDIC charged assessments. During the crisis, banks found that some forms of their funding quickly disappeared - including large brokered deposits that come from institutions. These brokered deposits are frequently referred to as “hot”money because they chase the best rates and move their money quickly, and it is these brokered deposits that have become a point of some contention.
The FDIC and the Fed now want banks to have stable sources of funding - from checking accounts of regular people and businesses, for instance. To incent them to limit the amount of brokered deposits, there is a new surcharge of another 0.1% or so that kicks in if these deposits represent too much of a bank’s total deposits.
And this, finally, is where BONY Mellon comes in.
When the European crisis was hitting in August, BONY – which is a custody bank and therefore has accounts with hedge funds and other large investors - was suddenly seeing a lot of cash being parked on its balance sheet. No one wanted to take any risk, so they just put their money with their banks. If you go back, you’ll probably see that all large banks had spikes in deposit activity at that time.
The difference with BONY is, as a custody bank, they do even less lending than regular banks. So they really didn’t have anywhere to put all the money they were getting,and the additional FDIC assessment that was going to kick in for the brokered deposits likely meant that BONY would have been losing money if they took in all of the deposits.
Given that, I think the NY Times should have spent a few lines indicating that BONY wasn’t planning to charge all customers this fee. In fact,they weren’t even planning to charge all large customers the fee.
The banks have stubbed their toes plenty in the past few years, but this is one instance where the whole story should have been told more fairly. Don’t think I’m getting soft on the banks,though - I’m still debating on how to address the ridiculous debit card fee.