Consumer Banking in the Post-Reform World

August 09, 2010 at 1:24 PM
It’s an understatement to say that events over the last three years made it difficult for managers to look beyond the next quarter.   Beginning in late 2007, financial institutions where walloped by a one-two combination of economic recession and legislative activism, the latter characterized by various laws and regulations affecting almost every aspect of consumer banking and culminating with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act.   During this period, many institutions were preoccupied with simply surviving.
It appears that the period of tumult has ended, and a new landscape is emerging from the haze.   True, the home foreclosure rate and unemployment rate remain very high, but the economy is expanding.   While the industry overhaul legislation remains to be fleshed-out by rulemaking, the fundamentals of it are clear.   It is now time for the survivors to begin to consider how to adapt and compete in the new environment.   As managers begin to develop plans for moving the business forward, there are many important considerations that will affect consumer banking in the years ahead.   To note just a few:
Different Profit Dynamics for Checking Accounts – For years, much of the industry built its consumer checking account strategy around free checking.   However, regulations pertaining to overdraft and NSF fees have permanently changed the profit dynamics of this approach.   Profitability will be further eroded by reductions to interchange fees on debit card transactions.   Consequently, many consumer deposit products and many of the consumer customer relationships will not be profitable as currently structured.   It is incumbent upon managers to refine their consumer deposit suite – with a focus on the checking account product set – to increase perceived value on the part of targeted consumers, ensure product line consistency with the bank’s positioning, and implement new pricing strategies to build back revenues.
Bigger Will Not Necessarily Be Better – Increased size and broader geographic coverage will bring more costs, increase the complexity of consumer compliance, and increase the potential for litigation.   All entities engaged in consumer financial services (with some notable exceptions) will be regulated by the Consumer Financial Protection Bureau (CFPB).   However, those institutions with more than $10.0 billion in total assets will be subject to direct examinations by the CFPB.   Practically speaking, this means they’re going to be subjected to a higher level of scrutiny and adherence.   Also, institutions above this asset threshold must establish a risk committee and will be subject to annual stress testing for capital adequacy.   The latter means that funding incremental growth of the loan portfolio through leverage will be constrained.   Marginal loan growth may need to be supported by more expensive capital, which will hurt marginal profitability.   Last, the Federal pre-emption standard has been weakened, so federally-chartered thrifts and national banks operating in multiple states will be exposed to greater risk of litigation from state authorities.   Managers need to account for these implicit and explicit costs when evaluating the relative attractiveness of incremental asset growth opportunities.
The Risk versus Return Equation Has Been Permanently Altered – Limitations have been placed on credit card issuers’ ability to revise interest rates and levy fees based on changes to a borrower’s risk profile.   Many of the mortgage products and pricing designed for the subprime segment have been curtailed or proscribed and residential mortgage originators must determine if the consumer has a reasonable ability to repay the loan.   The CFPB has broad authority to curb practices it deems unfair, deceptive, and abusive.   The latter term could be broadly defined and could conceivably include the rate of interest, various fees charged on the account, or inadequate disclosures.   Collectively, these changes mean that banks will not be adequately rewarded for serving subprime borrowers, will bear the burden of justifying any pricing that falls outside of industry norms, and will be incented to withdraw from serving segments where risks cannot be adequately priced.
The regulatory changes coupled with projected slow economic growth pose significant challenges to the consumer banking business for the foreseeable future.  Many of the strategies that helped generate growth before the crisis will either not be permitted or will be significantly less profitable.  Managers should plan accordingly.
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