A lot of people are talking about the new movie "The Big Short," which concerns the staggering sums earned by Wall Street trading firms on derivatives positions. It is a story that we all have heard of by now. But those moviegoers ought to think about the other Big Short - the one that is being perpetrated millions of times every day to consumers.
The Big Short I am talking about is the overdraft. Banks are on pace to earn more than ten billions in overdraft charges this year. Even after the implementation of opt-in rules, overdraft is still going strong.
This list shows the banks that have generated the most revenues from overdraft through the first nine months of 2015.
This data comes from call reports published by the FFIEC. The overdraft sum represents overdraft fees (excluding extended overdraft fees) for the first three quarters of 2015.
The "overdraft fees per hour" column shows the true scale of overdraft. JPMorgan Chase is drawing more than $200,000 on average for every hour of the day. Granted, I doubt that many of those fees are coming in the middle of the night and a large share is probably being booked at the end of the day, when checking debits arrive.
At first blush, it looks as if overdraft revenues fall in line with bank size. After all, the top three banks on the list are the three largest depositories in the United States. But that initial conclusion is not quite right, because the sum of consumer transaction account deposits is not at all linear to the overdraft fee revenues. Wells Fargo's rate of overdraft is far greater, after equalizing for deposits held, than is the case at either Bank of America or JPMorgan Chase. TDNorth earns only a fraction of the overdraft fees of those three, but in relation to consumer deposits, it outpaces the big three banks by a large margin. Citibank, often thought of as another of the truly big banks, lags far behind. (That's a good thing.)
Most exceptional is the result at Woodforest National Bank. Woodforest operates the bank stores located in many Wal-Marts. Their rate of overdraft in relation to their deposit base is outsized. Indeed, when controlling for deposit size, Woodforest is harvesting five to twenty times more in fees relative to the norm.
The Woodforest result underscores an important truth about overdraft - the cost of this product is mainly shouldered by lower-wealth households. The typical Wal-Mart shopper comes from a household with less than forty thousand dollars per year in income. While that is certainly not a poverty-level wage, it falls well below the median.
The class context impact matters because it illustrates an inequity within our payments system. If we accept the current approach to overdraft, then we rationalize a system that helps the rich at the expense of the poor. I understand that banks - like any other industry - are in the business of serving their most profitable customers. But that doesn't mean that it is appropriate to create a product that reaches so many people build upon a model of dramatic cross-subsidies. There are banks out there that derive three-quarters of their revenues from consumer checking via overdraft. At some institutions, top-line revenues from overdraft are greater than bottom line income across all product channels. It might be appropriate to cease to call these banks and instead to refer to them as "overdraft stores."
Consumers are not blind to pain of overdraft. While many do continue to pay the fee for the service from time to time, millions "walk with their feet" and leave the banking system all together. This creates negative externalities for all kinds of entities: small business, local governments, and fraud enforcement teams, to name a few.
People often assume that overdraft has been resolved by recent updates to opt-in rules. While that change did represent a substantial improvement in laws, more work remains to be done. American households are on pace to spend more than ten billion on overdraft fees this year. Does that sound like occasional use or more like a systemic short?
I understand the rebuttal to this argument: well, no bank can stay in business if it doesn't make money. I understand that. My critique is not that this should be free, but rather that the cross-subsidy that has become an expectation for most people is in fact a problem. Embedded in "free checking" is that banks will make that up with millions (or billions) in overdraft fees. The system is thus one where most ride for free but a few pay dearly.
Banks deserve to earn some money for providing a checking account. In my opinion, no reasonable person can argue that it deserves to cost nothing. In 2015, a typical checking account might come with as many as forty-five different functionalities. Nowadays, we take that for granted. Likewise, most competitive banks offer all of those services from branches as well as a variety of electronic access platforms. Sure, some might contend that the time value of money held at a bank provides a reasonable exchange. But that certainly does not hold in an area when the Federal Reserve is paying banks to take deposits. Banks are taking deposits as a matter of courtesy. True, interchange revenue helps as well. But is using a checking account for a month worth less to a consumer than the price of a single donut? Does a person derive more utility from a checking account or from the purchase of a single photocopy at a print shop? Would you prefer to download an advanced flashlight app more than you would dislike being unbanked? Unless you are a donut fiend, I think we both know the answer.