The $109 Billion Bank Hustle
Interoperability isn't just for telecom firms, email, and Facebook. In a high interest rate environment, it's also how to stop banks from scalping businesses and consumers.
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Last October, Consumer Financial Protection Bureau Director Rohit Chopra stood up at a banking conference and gave an unsettling message to the assembled crowd. He said, you make too much money by locking in your customers. He didn’t use those exact words, of course, but in a speech, Chopra talked about a shift in how he’s thinking about regulating banks. Instead of intrusive rules preferred by Obama era regulators, or no rules preferred by Trump ones, he is going to seek simpler market rules to foster fair competition in banking. Specifically, he wants to end the practice of banks making it hard to switch bank accounts and credit cards. This ‘lock-in’ method of business is costly to businesses and consumers who use our banking system, and in this piece, I’ll try to put a dollar amount on it.
Right now, credit card interest rates are at their highest level in forty years, despite delinquencies being very low. That’s not necessarily bad or unfair. After all, the Fed has been raising interest rates, which is the cost of wholesale credit, so banks are raising prices on the retail credit they deploy. However, if the Fed does cut rates, banks likely wouldn’t respond by cutting prices as quickly as they raised them. The expression of ‘up light a rocket, down like a feather’ applies. And we can see this dynamic, in reverse, with how banks handle deposits.
Most people and businesses keep their money in a deposit account, and get paid a bit of interest from their bank. Banks use deposits to finance loans, and keep the difference between the interest rate they receive on loans and the amount they pay to depositors, minus any loans that don’t get paid back. This is called the Net Interest Income, and it’s a big source for bank profits. JP Morgan alone earned $70 billion from NII in 2022.
The Commerce Department gives a weird name to bank revenue, calling it ‘financial services furnished without payment at commercial banks.’ This is because most people don’t actually pay any cash out of hand for a deposit account, but pay indirectly by getting a below-market rate on their deposit interest rate. And this amount has been going up way up. In absolute amounts, the dollar values are significant. I pulled data from the U.S. Bureau of Economic Analysis, and here’s the revenue increase over time in chart form.
Now, there’s nothing wrong with banks making money, but over the past decade, this increase occurred without any increase in the amount of value provided. Here’s Matthew Klein noting this phenomenon in the Financial Times:
Since the start of 2013, American consumers have boosted their spending on “financial services furnished without payment at commercial banks” by about 57 per cent. It’s been decades since this category of consumer spending has grown so rapidly.
So what’s going on? I’ve gone over how a credit card oligopoly - concentration in just six banks - squeezes us in various ways we don’t notice. But deposit accounts also foster higher profits, especially when interest rates are going up. Net interest margin - the difference between deposits and loans - goes up when the Fed raises interest rates, because banks immediately raise the interest rates of loans and credit products, but take their time raising interest rates they pay to depositors.
Theoretically, banks should correct this spread themselves through competition. If JP Morgan is paying me 0.5%, and another bank is willing to pay 1.5% for deposits, that bank should solicit my business. And to some extent that happens. Banks do compete over deposits by bidding to capture depositor money with offers of higher deposit rates.
But this process is quite slow. Even though there are banks that try to lure depositors, most consumers and small businesses don’t switch accounts very quickly because of lock-in costs. As Chopra said, “changing a bank account is a huge pain,” as ”direct deposits need to be reset, as do scheduled payments linked by ACH or debit card.“ To change bank accounts means redoing all of this, while making sure you have enough money to pay everything you need to pay. This ‘lock-in’ effect is somewhat similar to switching phone carriers without being able to move your phone number, or changing email providers without being able to forward email. It’s usually not worth it, because the friction - intentionally put there by incumbents - is too high.
How much does this lock-in effect matter? Well, Klein showed that two fifths of the increase in bank service revenue is a result of organic growth, aka people saving more money, while the other three fifths is pure pricing power. As he put it, “banks have made a lot of money off of consumers in the past few years by failing to adjust the interest rates they pay by changes in market conditions and by failing to adjust the interest rates they charge by changes in default risk.” So there’s been “a boom” for banks “with almost no increase in the value of the service provided.”
How much is this pricing power in absolute dollars? Banks had $239B in annual revenue from this line item in 2013, and $421B this last quarter. If you take three fifths of that amount, it’s $109 billion of extra revenue banks are getting from doing nothing except locking in consumers to their bank accounts.
And this brings me back to Chopra. The CFPB, because of a provision in the Dodd-Frank Reform Act, has authority to require banks to force interoperability of banking data. That means people would be able to more easily switch their bank accounts and credit card products, without having to lose all of their ledger data or having to redo all of their direct deposits. Neither the Obama nor the Trump administration did anything with this authority, but Chopra is going to exercise it, starting with letting people have freedom to move their own financial data.
Chopra is a leader of a new generation of regulators who see regulated competition, not intrusive rule-making, as the right way to redress inefficient and unfair practices. This rule-making, along with future rule-making to full ‘open banking,’ could save hundreds of billions of dollars of costs to consumers and businesses, who will benefit from removing friction in our highly inefficient and sticky payments system. It’s not that people will necessarily move their deposits or credit card accounts, but that after interoperability becomes the rule, they could do so. And that’ll mean banks will raise deposit rates and lower credit card rates more quickly just to make sure that consumers don’t leave.
The power to refine and improve our financial system, in favor of consumers and businesses alike, is already in place. Chopra is poised to use it.
But banks do not use deposits to "fund" loans:
"The problem with this model is that it is wrong (see Lindner 2015; Taylor 2016). Wrong in its conceptualisation of banks (which are not just intermediaries pushing around existing money, but which can create new money ex nihilo), wrong in thinking that savings or LF-supply have anything to do with “loans” or “credit,” wrong because the empirical evidence in support of a “chronic excess of savings over investment” is weak or lacking, wrong in its utter neglect of finance, financialization and financial markets, wrong in its assumption that the interest rate is some “market-clearing” price (the interest rate, as all central bankers will acknowledge, is the principal instrument of monetary policy), and wrong in the assumption that the two schedules—the LF-supply curve and the LF-demand curve—are independent of one another (they are not, as Keynes already pointed out)."