On today’s episode of the 5 Things podcast:
Have you even wondered how banks make money? Or why overdraft fees exist? After a listener asked, 5 Things Sunday Host James Brown got answers from USA TODAY Finance reporter Elisabeth Buchwald, Bankrate.com analyst Greg McBride, and economist Aaron Klein from the Brookings Institution.
If you have a comment about the show or a question or topic you’d like us to discuss, send James Brown an email at firstname.lastname@example.org or email@example.com. You can also leave him a voicemail at 585-484-0339. We might have you on the show.
Hit play on the player above to hear the podcast and follow along with the transcript below. This transcript was automatically generated, and then edited for clarity in its current form. There may be some differences between the audio and the text.
James Brown: Hello and welcome to Five Things. I’m James Brown. It’s Sunday, January 15th, 2022. Go Bills.
Every week we take a question and idea or concept and go deep. In this week we’re talking about one of my favorite topics, money, in some of the ways that banks make it, in particular fees. This episode is inspired by a listener named Mark Sublet. He sent me an email, so I called him. He’s a carpenter and owns a small business. When we talked, he was in the middle of a project painting 180 houses in Crystal Beach, Texas. In recent months, he found himself looking back at his past and all it took to get his business off the ground. He says, “Those early days were hard and banks made them harder.”
Mark Sublet: So we’re struggling, we’re barely making it. We’re getting all kinds of overdraft fees. And it struck me at that time in my life that out of all the people in the world that really can’t afford a $30 or a $36 overdraft fee, that was me. And I was like, “I can’t be the only one in a situation where I don’t have any money and they’re basically taxing me because I made a mistake or I don’t have any money.” So it seems like it’s set up to keep the poor poor and make the rich richer, and I didn’t like that. And because of that, I really don’t like banks.
James Brown: In hindsight, it makes them wonder why banks need to charge additional fees at all, especially if their core business is lending money with interest, or so he thought.
Mark Sublet: I want to know if my concept, my belief system about how this works is right. Am I wrong? Is there an economist or a banker that can say, “No, Mark, you’re not right. That’s not really how it works and this is why we do it this way.” Because I don’t have to be right, I just want to know why.
James Brown: So I asked a few people who would know beginning with USA Today personal finance reporter, Elisabeth Buchwald.
Elisabeth Buchw…: I think that’s a very normal question to have and concern. And it is kind of confusing, how do banks make money? They’re not exactly your friend even though they come off that way. So at a very, very basic level, the way banks make money is they take in money deposits and they offer certain interest rate on that to attract people to give them the money and hold it in their account. And what they do with that money, even though it’ll always show your balance, behind the scenes they’re kind of loaning out your money to other people and they charge an interest rate on that, which is typically a lot higher than the interest rate you’re earning just from keeping your money in the bank there. So it’s called the spread. That’s how banks in a very basic sense would make their profit.
Now they have all different kinds of fees that they set up. Overdraft fees really do contribute to their profits. It could be as much as a billion a quarter, I believe. And there’s a lot of different products that they’ve come out. Actually most have credit cards, so that’s a whole different topic. But again, on the most basic level, it’s the spread between what they make loaning and what they give customers for depositing their money with them.
James Brown: Or as economists Aaron Klein put it.
Aaron Klein: So if you think of those three-legged stools, so to speak, it’s lending, payments, fees.
James Brown: You may not know Klein’s name, but odds are pretty good you’ve heard of his work. His focus is financial regulation. He worked in a Department of Treasury during the Obama years. When the housing market collapsed in the late 2000s and several major banks with belly up, he was one of the writers of two pieces of legislation that made the new rules for banks. In recent years, he’s been a senior fellow at the Brookings Institution. That three-legged stool he mentioned a minute ago can be broken down into a lot of pieces. He says the pieces depend on which banks were talking about.
Aaron Klein: One is interest, right? The difference in what they get from loans versus what they pay on deposits. The second is payments. So every time you swipe your debit card, you’re issuing bank is making money and their other payment services they provide. And the third leg are fees. So overdraft fees, account fees, wire fees, et cetera.
James Brown: Klein has become an outspoken critic of overdraft fees, even testifying to Congress about it. He says his stance on the fees stems from a chance encounter he once had at a bank.
Aaron Klein: I used to take my daughters when they were younger for ice skating lessons on Saturday morning. And after ice skating, we’d go to the local bank where I do my banking and the girls would get lollipops, I’d put a little money in their kids’ account, a little financial literacy. They thought the bank was cool because it often meant candy and a nice time.
And so one of these Saturday mornings, I’m there and they’re two women in front of me in line. One is at a teller and she’s having this problem where she’s depositing a check, but the teller’s telling her the check won’t be available to her account till Wednesday or Thursday. And she’s realizing the results are going to be overdraft fees. And she’s getting more and more upset. “How many overdraft fees? 35 bucks, 70 bucks? You mean there’s more than one fee, but the money’s there. You know I’m good for it.” And the teller says, “I’m sorry. I can’t do anything about this.” She said, “But you know that the check’s good. I’ve always done this deposit.” And finally the other woman in line walks up to her, taps her on the shoulder and says, “I can help you. What you do is you go around the corner, you go to the check casher, for 20 bucks that person will make the check cash. Come back, deposit your cash, you won’t have any fees.” And the teller says, “Yeah, the cash will clear immediately.”
And all of a sudden a light bulb went off in my head. I’d been told that check cashing was about unbanked, it was about branches and hours and locations and time. And here we are, three people, all in the bank, the bank’s open, we’re all inside, it all works. This person’s cheapest best alternative was to go to a check casher and you say, “Okay, well Aaron, that’s an anecdote. Tell me data.” I said, “Well, a different way to look at this story is three people walk into a bank. One is the problem, one knows the solution, and the third thinks they’re an expert on banking services for low and moderate income people.”
So that set me off on a whole research curve, and I’ve been able to show and demonstrate 70% of check cashing customers in America have a bank account. Think about that. 70% of the… Seven out of 10 people in a line at a check cashing store have a bank account. So why are they in the check cashing store? Turns out one of the big problems is because check cashing is immediately, depositing a check in the bank takes days. And that set me on a bit of a quest to try and improve America’s payment system, which drives bank overdraft fees, check cashing fees, late fees, and has become a giant tax on people living paycheck to paycheck.
James Brown: So I asked Aaron the big question, why do these fees exist?
Aaron Klein: Overdraft fees are a combination of two different concepts, right? The first was we want to make this expensive and punitive to discourage people from spending money when they’ve run out of it. So they set this fee usually at 35 bucks. And legally to get a… Call this a fee and not a loan, right? I’m an economist. If I give you an overdraft or if I give you a line of credit, they’re the same concept, right? I’m lending you money that you don’t have. You’re paying me back more at a later date. But we have a bunch of laws about lending and interest rates and regulation about this where overdrafts at 35 bucks. Everyone’s heard the story of the $2 cup of coffee that generated a $35 overdraft fee, right? That interest rates on that would be astronomical. So it was legally, in the ’90s, considered a fee for service that had to be done kind of optionally or not that common.
What started out that way became a huge cottage industry. The data show that about one out of 12 Americans are heavy overdrafts, but they use 10 or more overdrafts a year, spending $350 or more a year. These are people living paycheck to paycheck. I believe that number has gone up over the last several decades in part because more Americans are living paycheck to paycheck. And so a group of banks, large and small, realize that these folks for overdraft was their only real alternative or other alternatives were even more expensive, so they could get a lot of money off of these customers. A heavy overdraft customer became very profitable for banks and certain types of banks specialized in that, one.
Two banks realized that they could do things, change their business model slightly and increase the amount of overdraft a person has. So for example, what if you reordered your transactions not from every time you swiped your debit card, but at the end of the day, you reordered them from the highest transaction to the smallest? More people would overdraft because you’d run your account out. What if I post debits to your account before I post your credits? And some banks started doing these tricks and they started getting more and more fees. And what’s important to understand about overdraft, it’s almost all profit. Unlike loans where some people default, the bank gets paid back the very next deposit that comes into your account. So these things became incredibly profitable. Look, there’s a bank CEO out of Minneapolis who named his yacht Overdraft.
James Brown: That CEO’s name was Bill Cooper. He ran the Minnesota base TCF National Bank for decades. In 2017, he was sued by the federal government for tricking customers into costly overdraft services. Cooper died shortly after that suit was filed. A year later, the suit was settled. The bank agreed to pay $25 million to customers in restitution and ultimately a $3 million penalty. USA Today finance reporter Elisabeth Buchwald says government pressure is one reason why banks are moving away from these fees.
Elisabeth Buchw…: Elizabeth Warren has been a big critic of banks profiting from overdraft fees. And the reason why I think a lot of particularly democratic lawmakers have made this a talking point in these testimonies is because overdraft fees affect lower income voters, it affects mainly people of color, and those are people that they’re often trying to get votes from or that they represent in their districts. So they feel especially passionate about it.
James Brown: And the banks have responded. That’s evident if the fees themselves.
Greg McBride: Overdraft fees are a lot like the speeding tickets of banking.
James Brown: That’s Greg McBride. He’s Chief financial analyst at bankrate.com. That’s a news site focused on the banking industry.
Greg McBride: If you overdraw your account, if you try to initiate a payment for which there’s not enough money in your account, there’s a penalty for that.
James Brown: In a report released last year, Bankrate analyze overdraft fees in 25 markets. Pittsburgh had the highest fees on average, roughly $35. Miami had the lowest, roughly 21 bucks.
Greg McBride: Some banks are still charging the same $36, $38 fee they’ve always been charging while others have changed their policy and they’re now charging significantly less. Despite the sort of well publicized moves by some of the larger banks to reduce the price point, move away or adopt new policies, from the consumer’s standpoint, these are not going away anytime soon. We found that 96% of accounts still charge an overdraft fee. 87% still charge what’s called a non-sufficient funds fee, which is if you don’t have overdraft coverage and you just prefer that your payments be denied if there’s not money in the account.
James Brown: McBride says just about every bank has tools to help us avoid overdrafts.
Greg McBride: I would say it is now easier than ever to avoid fees. So whether we’re talking about overdraft fees, ATM fees, just account maintenance fees, yes, the fees are a lot higher now than they were 20 years ago, but they’re also much easier to avoid. What counts in terms of avoiding overdrafts is, what’s the available balance? And so you want to check, make sure you have sufficient available funds before you initiate a transaction. That’s rule number one in terms of avoiding overdrafts. Set up a line of defense, set up a link between your checking and your savings account. Maybe you just maintain a modest savings account where you have your checking account just as a buffer. And that way if you do overdraw, it’s your money. It’s not the bank’s money that covers that shortfall. It’s another way to avoid those fees.
James Brown: Greg McBride, any famous last words?
Greg McBride: Just be mindful of the available account balance. Yes, overdraft fees are moving in the right direction, but it’s not going to be fast enough to solve the problem if you don’t have some of those good habits in place. One other one I hadn’t mentioned yet is sign up for email or text alerts that let you know when your balance gets below a certain threshold. That way you can be proactive and you can move some money from that savings account into the checking account and avoid incurring overdrafts.
James Brown: If you like the show, write us a review on Apple Podcasts or wherever you’re listening. And do me a favor, share it with a friend. What do you think of the show? Email me at firstname.lastname@example.org or leave me a message at 585-484-0339. We might have you on the show. Thanks to Mark Sublet, Greg McBride, Elisabeth Buchwald and Aaron Klein for joining me, and to Alexis Gustin and Shannon Rae Green for their production assistance. For all of us at USA Today, thanks for listening. I’m James Brown. And as always, be well.