These are not happy times for banks. The industry’s revenues, which consist of interest income on loans and investments (net of the costs of deposits and other sources of funds) and fee-based income, are under pressure. Weak economic activity is reducing demand for loans and bank services. Defaults by borrowers are causing banks to forego interest income on some loans. And in the aftermath of the financial crisis, bank regulators and legislators are unleashing a flood of new rules and laws that threaten to take a big bite out of the industry’s revenues.
The new laws include the Credit CARD Act of 2009, which aims to protect consumers from unfair credit card practices, that went into effect in late February, and Regulation E, issued by the Federal Reserve Board, which is designed to give users of debit and automatic teller machines the ability to decide whether they wish to accept overdraft services. These services charge a fee for allowing a transaction to take place when the depositor doesn’t have enough money in the account to cover the sum. The rule takes full effect in mid-August. Numerous other new laws and regulations are under discussion, including restrictions on the big banks’ proprietary trading and on the use of derivative instruments.
Regulation E alone is expected to make a big dent in many banks’ noninterest income, but banks won’t know until after mid-August just how many of their checking account holders have opted for overdraft services, and the rule’s impact will depend on how often depositors overdraw their accounts. Minneapolis-based U.S. Bancorp (USB) estimates that the rule could lower its annual fee income by $200 million-$300 million, but the company is larger than most regional banks and its mix of activities that generate noninterest income is fairly diverse. It also expects the Credit CARD Act to have a $100 million annual negative impact on its total revenues, which include net interest income. Ohio-based Fifth Third Bancorp (FITB) figures Regulation E will reduce fee income by $20 million per quarter. Bank of America (BAC) estimates the annual impact of the Credit CARD Act at $900 million. JPMorgan Chase & Company (JPM) estimates Reg E and the CARD Act will reduce its annual income by $500 million and $500 million-$750 million, respectively.
The banks aren’t saying much regarding how they intend to offset the effects of new laws and regulations on their revenues, no doubt to avoid arousing the ire of regulators, lawmakers, and customers. But the banks have some options. Among them, they might raise fees for wealth management and other services. The banks might require depositors to maintain larger balances or pay maintenance fees on their accounts, such as Bank of America’s proposal to levy fees on checking-account holders who don’t maintain minimum balances or utilize other financial services offered by the company. Banks could add revenue-generating financial services to their current lineup. The industry may also have some room to offset lost revenues by lowering operating expenses.
Will the banks be able to make up the expected loss of revenue? Probably not in the short run. Competition within the industry is likely to limit the banks’ ability to raise fees for services or impose new fees, especially in times when economic weakness already depresses demand for those services. A bank’s ability to raise fees may depend on how sticky its customer base is. For example, customers that do a lot of on-line banking, with automatic bill-pay services, may find it more cumbersome to switch banks than customers who bank at physical branches. Additionally, it takes time to ramp up new services, and early on, companies frequently don’t break even when they embark on new lines of business. Some in the bank industry probably will experience declines in their fee-based revenues in the next several quarters.
By mid-decade, however, most banks probably will have adapted to the new regulations. Moreover, stronger economic activity by then should lift demand for loans and bank products, with a resulting positive impact on bank revenues. In the meantime, however, the new regulations could put a lot of pressure on bank revenues.