Getting Banks Back Into Banking

Banks used to be in the business of gathering deposits and making loans. Today, they are in the business of gathering fees and making trades.

Being an American banker today means living under the thumb of regulators who demand that you lend money at extremely low interest rates, while trying to avoid making bad loans that would reduce your capital and potentially require a federal bailout. The bigger the bank, the greater the pressure.

In this environment, depositors are a nuisance unless you can extract hefty fees from them. You have to track their money and hold part of it in cash so you can meet withdrawal demands, and you can’t lend most of the rest at very high rates anyway. When you do lend money, you must generate reams of paperwork to satisfy your examiners. If things go badly for borrowers, you can expect to be accused of “predatory” lending. And if you try to foreclose on loans in default, you had better make certain that all your paperwork is in order, lest the collateral that secures your capital – and your depositors’ deposits – be lost amid charges of “robo-signing.”

Yet bankers were not forced out of their traditional business by heavy-handed or clueless regulators. Years before the housing bubble burst and the financial crisis began, bankers willingly exchanged much of their slow-but-steady business for the faster-buck pursuit of fee and trading profits. Banking circa 2005 was a race to issue mortgages that could quickly be resold, in the case of high-quality borrowers, to Fannie Mae and Freddie Mac or, in the case of more dicey borrowers (the phrase “anyone with a pulse” was widely used), to private investors in the form of securities that were packaged on Wall Street. Banks could then seek to make additional profits by trading those same securities.

Traditional banking serves a very important economic purpose. By gathering idle cash and lending it to borrowers who can put it productively to work, banking makes society as a whole wealthier over time. It is a risky business model, because only a thin foundation of bank capital supports a big structure of loans and deposits, but the advent of federal deposit insurance and closer inspection bought decades of stability until the fast-buck boom went bust.

Now our post-recession economy is having trouble gaining steam, and one of the reasons is the anti-lending bias in today’s banks.

Lately, however, regulators have started to pressure banks to cede some of their newer revenue sources. This might only inspire banks to find new ways to make quick money, but there is at least a chance that the new demands might lead banks back to their old way of doing business.

One area where banks are seeing restraints on their pursuit of fee revenue is in overdrafts. Regulations issued by the Federal Reserve Board in 2009 prohibit banks from processing debit card or ATM withdrawal charges that put a customer’s account into the red and then charging that customer a fee on the overdraft unless that customer explicitly consents. Since then, many people have done just that, opting into overdraft protection programs that brought in $31.6 billion for banks last year, according to Moebs Services, a Lake Bluff, Ill., research firm. Around 15 million Americans overdraw their accounts more than ten times a year, each time paying overdraft fees ranging from $25 to $35, the firm said.

Richard Cordray, director of the Consumer Financial Protection Bureau (CFPB), has launched an inquiry into these overdraft protection programs, looking at marketing materials that may mislead customers into consenting to “protection” that could cost them hundreds of dollars in avoidable fees every year.

Last week, four people with knowledge of the inquiry told reporters that investigators are examining the practices of nine U.S. banks, including national players JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC) and Bank of America Corp. (BAC); regional players U.S. Bancorp, Regions Financial Corp., and PNC Financial Services Group Inc.; and three others that were not named.

In another development last week, the Federal Reserve and four other U.S. agencies essentially admitted that the so-called Volcker Rule, restricting banks’ proprietary trading, is such a mess that they will not be able to actually write the regulations needed to implement it until after the planned July 21, 2012, compliance deadline.

According to the Federal Reserve, banks will now have two additional years to comply with the as-yet-unwritten rule. Now they need only make a “good faith” effort to “conform” their activities and investments to the still-undefined standard.

Like most owners of small businesses, I am not directly affected by mega-issues such as the Volcker Rule. I don’t need my bank to provide me with foreign currency hedges or interest rate swaps. I do, however, need my bank to provide me with credit and to hold my company’s cash. And, like many business owners, I am seeing the results of the tighter credit environment firsthand.

Back in 2008, when the financial crisis first hit, I drew down a $50,000 credit line that had been issued to our company at 0.75 percentage points above the prime rate. With credit markets freezing up and the government’s response still uncertain, I sensed that this was a use-it-or-lose-it situation. I kept the money borrowed more or less continually since then, even though the business had more than enough cash (earning close to zero) to pay it off. I was willing to spend about $2,000 a year in net interest cost to ensure that the funds would be available if things got really tight.

Recently, the bank told me it was raising the interest rate on my credit line to 3.25 percent above the prime rate (which is also at 3.25 percent right now), bringing the total cost to 6.5 percent. As any savvy banker might have predicted, rather than paying nearly $3,125 in annual interest costs, I repaid the credit line. My bank’s profit on the transaction went from $2,000 to zip.

In normal economic times, that would have been bad news for the bank. In our present world, however, the bank was probably happy to have my line of credit paid off. It meant one less “risk” in the eyes of regulators, even though the bank (which sees our cash inflows and outflows) knows that our business is good and our cash flow is stable.

In March, Bank of America announced that it was looking into ways to restructure checking account fees in order to charge more. JPMorgan Chase and Wells Fargo similarly introduced new programs, which impose monthly maintenance fees for many customers, in 2010 and 2011. Wells Fargo’s retail division relied on fees, including overdraft fees, for nearly a quarter of its net income, or $4.3 billion, in 2011, according to financial disclosures, Bloomberg reported.

It’s going to be very difficult to get normal economic growth in an abnormal situation, and there is a lot about the financial system that is abnormal. Depositors are paid almost nothing for their deposits, borrowers pay unrealistically low rates for credit that is unreasonably hard to get, and banks are not particularly interested in traditional banking. Just getting things back to normal would be a major step forward.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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