By Eric Taylor, director of UX research and strategy at Varo Bank
Shortly before the Covid-19 pandemic hit, I had a fascinating conversation with a challenger bank customer — let’s call her Jennifer. Jennifer is a nurse practitioner, in her early thirties, and lives in Atlanta. Towards the end of the interview, when I asked her to give me three words that came to mind when she thought of her former brick-and-mortar bank, she hesitated for a moment and then said:
I won’t name the bank, but let’s just say that it’s a large national bank, which every American would recognize. When I dug a bit deeper and asked her about why she felt “professional thieves” was an appropriate descriptor, she explained that when she’d been in nursing school, money had been tight and she’d been dinged with numerous overdraft and minimum balance fees. Then, in her final year of studies, her financial situation got even tougher, and she was forced to max out her credit cards. She’d only recently been able to rebuild her credit into prime territory. She was now with Varo (my employer), a pure digital bank, which she felt gave her the same level as security as her old brick-and-mortar.
As a UX researcher in the fintech space, I have the opportunity to talk to people all across America about their financial lives. Jennifer’s conflicted relationship with traditional banking is a familiar story to those of us in the Fintech space. On one hand, the familiar, old school banking relationship feels secure and safe, and on the other, it feels like you’re being taken advantage of (to put it politely). Unsurprisingly, research has shown that most people who switch over to digital banks do so because of excessive fees and because they feel undervalued as customers.
It’s not your imagination. Bank fees are increasing.
Jennifer’s perception that bank fees have become exorbitant is grounded in reality. Following the 2008 crisis, banks were faced with a low interest rate environment and diminished income from securitization, trading, and real estate investments due to the economic downturn. In the ensuing years, big banks filled much of their revenue shortfall by raising fees—a lot. These service fees have increased both absolutely and as a percentage of noninterest income since the 2008 recession. This is part of a larger trend. According to a recent Cleveland Fed study, service charges increased from 14% of noninterest income in 2001 to over 25% in 2018.
Fast forward to 2019, when US banks raked in roughly $11 billion from overdraft fees.
Let’s not mince words. Fundamentally, these fees are about monetizing two things:
1) Customers’ mistakes (when customers don’t realize they’re overdrafting, or dipping below minimum balance threshold)
2) Customers’ desperation (80% of overdraft-related fees are borne by only 9% of accounts — the most needy folks, who on average carry a balance of $350)
On a functional level these service fees are analogous to payday loans, in that they act as a stopgap when customers have lumpy cashflow. However, in most cases, the implied interest rates and fees associated with overdraft loans are actually higher than the interest charged by payday lenders for small loans.
Also, it should be underscored that lower income folks and people of color are the hardest hit by banking fees. African American people pay, on average, $190 more in costs and fees for maintaining checking account than do whites. Latinx pay an average of $262 more in fees when banking. It’s no wonder that recent studies show that financial services remains the least trusted sector in the American economy.
Big banks can’t evolve, because they’re handcuffed by their business model
I recently read an interview with Jamie Dimon, the CEO of one of America’s biggest banks, in which he declared that the COVID-19 crisis was a “call to action for business and government to think, act and invest for the common good”. He also had some inspiring words to say about leveraging “this moment to think creatively about how we can mobilize to address so many issues that inhibit the creation of an inclusive economy and fray our social fabric.” These are admirable sentiments, but also quite problematic, since, as mentioned above, in 2018, 25% of big banks’ income came from regressive “service” fees (which include overdraft fees and minimum balance fees) that impact lower income and people of color disproportionately.
So Dimon is in a dilemma. On one hand, he wants to “think creatively” about how to make our economy more fair and inclusive, but on the other, his bank’s shareholders would be apoplectic if he suddenly renounced 25% of J.P. Morgan Chase’s income for… ethical reasons. Conclusion: despite all the high-flown rhetoric, eliminating or significantly reducing fees does not appear to be viable options for incumbent banks.
When the US economy opens up again, and starts to rebuild after the COVID-19 pandemic, traditional banks will be facing steep losses from bad loans, sketchy investments, and decreased deal flow. Income will be reduced across most of their business lines (maybe this is why Warren Buffet recently sold major holdings in Goldman Sachs, Wells Fargo and JP Morgan Chase). The economic situation will be dire, and consumers will be hurting. Big banks know this, and are setting aside reserves to cover a tsunami of defaults. In extremis, some small and mid-sized banks will fail, while others, especially the larger, more well-connected ones, will receive taxpayer-funded bailouts. Based on recent history, and their single-minded focus on shareholder returns, it’s highly likely that these same institutions will once again seek to offset income shortfalls by raising fees. After all, extracting fees from their customers is a critical part of their business model. It’s in their DNA.
This is already happening as we speak, with banks raking in near record fees, often from consumers that have been hardest hit by the Covid-19 epidemic.
Americans will become less tolerant of fees as crisis deepens
Clearly such scandalous behavior will not win the hearts and minds of American consumers. We’re facing the most challenging economic environment since the Great Depression. Though we’re in the early days of this crisis, Americans are already saving more, and becoming more frugal and price sensitive. This trend towards frugality will intensify over time. On a societal level, as in the last recession, we’ll probably see a lot of anti-big bank sentiment (think Occupy Wall Street, but broader-based). Both these factors will cause consumers to become far less tolerant of incumbent banks’ gratuitous and unfair fees. Traditional banking relationships will hit the skids… and Americans will optimize their finances.
But unlike the previous crisis, when alternatives were limited, there are now a surfeit of options in the US financial services space. Consumers will do their due diligence, and leave brick-and-mortar banks in droves. They’ll go to new digital players, many of which charge no, or minimal fees, thanks to their leaner, streamlined cost structures. Disruption can be messy, but this transition to purely digital financial platforms will be relatively seamless, given that the vast majority of people are mobile-first anyway, and have adapted fluidly to life without bank branches during the current COVID-19 crisis.
Furthermore, retention numbers should be solid—our surveys clearly show that challenger bank customers feel much better about their respective banks with regards to fairness and transparency than peers who bank with incumbents.This isn’t surprising, given that many of these fintechs have adopted a more empathetic, equitable approach towards their customers, and prioritize inclusion, while larger banks are burdened with a lingering legacy of exclusion (e.g., redlining) and other appalling behavior (e.g., Wells Fargo’s unauthorized account openings, etc.).
Banking traditionalists might bridle at this scenario— “Good story, but digital banks’ market share is minimal, and they don’t have the robust product suite that we can offer. And our relationships are sticky like glue!”
This is probably the same thing that large incumbent brokerage firms said when eTrade came on the scene in the 80’s, when, if you were lucky, you paid about $45 per trade. In the ensuing years, the entire industry was transformed as digital players devoured market share. Now people pay $0 per trade. The more strategically-minded traditional brokerage firms painfully adapted to the new paradigm and lowered fees. Those that didn’t lower fees went the way of the dodo bird and Google Glass. This time around, the shift towards pure digital solutions will occur much more rapidly.
A paradigm shift towards a customer-centric, tech-forward approach to banking
All of this bodes well for nimble and mission-driven challenger banks, which are far more attuned and responsive to customers’ needs than incumbent banks. But more importantly, the embattled American consumer will get a better deal that they’re currently getting. They’ve worked hard for their money, and don’t deserve to be treated like ATM machines by their banks.
Over the last few years, fintechs and challenger banks have earned the trust of millions of Americans from all sorts of backgrounds, folks like Jennifer . Going forward, these numbers will only grow, as people continue to look for more ethical digital alternatives that treat them with respect, and give them the fair deal they deserve.