The Breakdown | Explaining Southern California's economy

How will small banks handle Bank Transfer Day?

An Occupy Wall Street image for Bank Transfer Day.
An Occupy Wall Street image for Bank Transfer Day.
tomblanton1957/Flickr (cc by-nc-nd)

Even though Bank of America has made the unusual decision to rescind its proposed $5 debit-card fee, apparently bowing to the consumer revolt that this fee provoked, plenty of customers may still move their accounts to credit unions and community banks on Bank Transfer Day this Saturday. Credit unions are launching efforts to promote themselves to prospective depositors; some are also expanding their banking hours.

There's skepticism that customers really will migrate from big banks to small banks en masse; a previous attempt to spur a revolt, promoted by the Huffington Post, didn't have much impact. And even if hundred of thousands of customers make the move, that's unlikely to significantly damage large banks, like BofA, Wells Fargo, and Chase, which have billions in deposits. There would need to be a Bank Transfer Day...pretty much every day to make a difference.

But what about the other side of the equation? Can small banks really handle the sudden infusion of new money?

You might say this is a problem that credit unions and community banks want to have. But you need to take a closer look at the business of small banks.

A sudden uptick in deposits is only a good thing if those deposits can be put to work, earning a return. Credit unions typically do this by making loans to their members, offering lower interest rates than big banks. Small community banks operate more like big banks, issuing loans to whomever they think is worth the risk. Both types of institution also compete for deposits with big banks by paying interest on accounts, usually a little more than the big banks offer. They also avoid nickel and diming customers with fees.

But the last thing they want is to have too much money sitting, so to speak, in the vault. For a bank, this is a way to actually lose money and go out of business, even as deposits grow. Holding the money costs money. Lending the money makes money (as do various fees, on things like wire transfers and bill-paying services). If the former costs more then the latter can support, the bank has a problem.

Marketplace's Bob Moon did a story on this about a year ago. He found a credit union in Nevada that was actually paying customers to withdraw money. Why? Because the credit union couldn't figure out how to make enough interest on its deposits to cover the cost of retaining them. 

The current economic climate is making it tough for smaller financial institutions to put their capital to work. Interest rates are at rock-bottom levels. But equally troubling is the high-risk business and economic environment. The more money that small banks and credit unions have, the more effort they're going to have to expend to find borrowers to whom they can make performing loans. 

You can see how this is a challenging proposition when unemployment is at 9 percent nationally and near 12 percent in California. 

And besides, why would you want to invest in small businesses if there's limited demand for goods and services in the economy right now? To make matters worse, Americans have been saving more money since the financial crisis (which is money than it costs banks to hold) and dialing back on household debt, which means lower credit-card balances.

There's also the question of the quality of the deposits you attract. Big banks are responding to small depositors — customers who keep relatively tiny amounts of money in the accounts — by forcing them to pay the big banks for what amounts to services: checking, ATMs, etc. 

Credit Union Times just published an entire article on the issue. It's important to remember in this context that not all accounts are created equal. For every lifelong relationship, punctuated with car loans and home loans and personal loans and CDs and substantial deposits, there are...well, freeloaders:

The challenge for credit unions is this,” maintained Bill Handel, vice president-research/development at Raddon Financial Group, the Chicago consultancy, “If indeed consumers do begin to migrate their accounts to credit unions, the credit unions have to be willing to take the bad with the good. The bad is the single-service, low-balance checking accounts which will need to be subsidized by the rest of the membership.”

The good part, said Handel, “is the accounts where relationships are built. But if too many bad checking accounts are attracted and the credit union is not successful in cross selling, then at some point I believe they will need to move away from free and move toward a relationship-based pricing structure.

So the small banks become just like the big banks. Except they have worse websites and fewer branches.

Ultimately, this could point to a problem with the traditional banking model — be it at big banks, small banks, or credit unions. Basic deposit services — checking and savings accounts, for example — are money-losers, or at best low-margin in nature. The action is in loans, often to credit-compromised borrowers, and high-interest-rate credit cards.

So maybe a bigger shift is necessary. I've argued (as have others) that the Post Office might be able to save itself by becoming a low-cost basic bank, offering rudimentary financial services beyond the money orders it already writes. Technology companies could also enter the picture, especially if they can easily facilitate transactions, as Google is doing with Google Wallet.

As it stands, however, Bank Transfer Day has allowed people to better educate themselves about their personal financial options. And that, in the end, is a good thing.

Follow Matthew DeBord and the DeBord Report on Twitter.