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Banking the Unbanked: The Past and Future of the Free Checking Account

Published by Anonymous (not verified) on Fri, 30/07/2021 - 8:18am in

Stein Berre, Kristian Blickle, and Rajashri Chakrabarti

 The Past and Future of the Free Checking Account

About one in twenty American households are unbanked (meaning they do not have a demand deposit or checking account) and many more are underbanked (meaning they do not have the range of bank-provided financial services they need). Unbanked and underbanked households are more likely to be lower-income households and households of color. Inadequate access to financial services pushes the unbanked to use high-cost alternatives for their transactional needs and can also hinder access to credit when households need it. That, in turn, can have adverse effects on the financial health, educational opportunities, and welfare of unbanked households, thereby aggravating economic inequality. Why is access to financial services so uneven? The roots to part of this problem are historical, and in this post we will look back four decades to changes in regulation, shifts in the ownership structure of retail financial services, and the decline of free/low-cost checking accounts in the United States to search out a few of the contributory factors.

The Unbanked
The economics of banking do not incentivize the delivery of financial services to those who may need them most. Since profits at retail banks are driven heavily by the size of the balances their customers deposit or borrow, product offerings and marketing efforts are disproportionately focused on clients with higher levels of income and wealth. Checking accounts display the characteristics of a good that has a high degree of income elasticity for lower-income households. In other words, a checking account is a good that lower-income households may choose to forego if household budgets are tight (as during a spell of unemployment); meanwhile, checking accounts have near-universal penetration among wealthier households. For a subset of consumers, estimated by the FDIC in 2019 to be just over 5 percent of the population, basic account access remains lacking, particularly among those with irregular incomes, less documentation, and a lack of credit history.

Significantly, almost half of this unbanked group previously had bank accounts and now choose not to have one. Reported factors in this decision include distrust of banks, high fees, or large minimum balances. Although the size of the unbanked population has been falling over time, it tends to go up and down with the state of the economy and level of employment, having recently peaked at 8.2 percent of U.S. households in 2011 and risen again as the result of the pandemic, underscoring that for poorer households, checking accounts are often a good they choose to forego when income falls.

Those without bank accounts still need financial services, including money transfer and credit. According to research by Mehrsa Baradaran on low-earners in How the Other Half Banks, expenditure on financial services by unbanked households could amount to as much as 10 percent of their income. Often, this spending is due to high interest rates (on such services as payday loans), wire fees (especially for those providing or receiving remittances), or overdraft/transaction fees on transaction accounts.

Low-cost, low-minimum bank accounts were once widely available in the United States. In the 1960s and 1970s, an era of regulated deposit pricing, banks competed for new depositors through aggressive advertising and incentives (the proverbial toaster) and offered low-fee checking accounts with low or no minimum balance requirements. Customers with larger balances cross-subsidized those with smaller balances, since the cost of servicing smaller accounts was often greater than the revenues they generated. The repricing of this era was concurrent with the Savings and Loan Crisis and the associated declines in financial inclusion and access to low-cost financial services products have continued to this day.

This post looks at some historical factors that accompanied changes in the supply of checking accounts to low- and moderate-income households in the United States. Part of this change in supply was structural, as institutions that had been founded to serve low- and middle-income communities either changed strategy or were acquired. Other changes happened at a product and customer level as banks reduced the cross-subsidies from higher-balance customers to lower-balance ones through minimum balance requirements, increased account fees, and overdraft charges.

Comparative Market Structure
All countries face challenges in achieving full financial inclusion, but the United States is relatively unusual among richer countries in the size of its unbanked and underbanked population. In neighboring Canada, for example, more than 99 percent of the population has access to a basic transaction account, including 98 percent of the poorest 40 percent of the population. Japan, Germany, Singapore, and the countries of Scandinavia show similar levels of access. The FDIC’s 2019 Survey of Household Use of Banking and Financial Services, in contrast, showed that about a quarter (23.3 percent) of U.S. households with annual incomes of less than $15,000 were unbanked, as were 10.4 percent of households earning between $15,000 and $30,000.

The United States is also somewhat unusual among wealthier countries in the scale of its not-for-profit banking sector. The United States does not have a universal Giro- or Postbank, as in much of Europe or Japan, and although it does have a vibrant credit union sector (accounting for about 8 percent of all banking assets), the mutual banking sector is smaller than in many other OECD nations.

This was not always the case. As recently as the 1970s, mutuals (thrifts, mutual savings and loans [S&Ls], and affinity-based mutuals) accounted for half of the residential lending market and commanded a significant share of the deposit market. A large number of these mutual banks were founded in the late 19th and early 20th centuries with the goal of ensuring financial inclusion for the working poor, at a time in which banking services were provided primarily to the well-to-do. Their missions were sometimes rooted in communitarian self-help and sometimes in paternalist philanthropy. Mutual savings and loans were present in most parts of the country and savings banks were once particularly prevalent in the cities and towns of the northeastern United States. Fraternal and friendly societies, including provident societies, also provided financial services as part of lodge, club, or church membership.

FRED data show the rapid decline of mutual banks in the U.S. banking market, both in terms of their number and their assets. In the chart below, the rapid fall in the deposit share of mutuals between 1985 and 1995 is particularly apparent. Many of these organizations still exist, but are no longer mutual-based, having demutualized or been acquired by for-profit commercial firms and migrated upmarket along with their customer base.

 The Past and Future of the Free Checking Account

While traditional mutuals have declined, there has been a revival since the 1980s in credit unions. Like the mutual savings banks and savings and loans, credit unions have a mutual structure, more akin to a not-for-profit, usually linked to some form of employer, professional affiliation, or local geography. While credit unions have grown their deposit
base at nearly 7 percent per annum on average since the 1980s, nominal growth of other mutuals (savings banks, S&Ls) has been negligible.

Over this same period (since 1989), commercial banks have grown in scale and scope, with total deposits growing from $2 trillion to over $17 trillion today. The acquisition wave that began in the 1980s has been associated with a commercial banking sector that is dominated by regional and national banking networks, which market themselves based on brand and convenience and do not generally compete on price in the market for retail deposits. The top four banking groups now account for more than 35 percent of U.S. commercial bank deposits.

The Great Repricing
Many factors came together in the 1970s and 1980s as banks began differentiating between higher- and lower-balance customers. Because deposit markets in this era were still very local and data on retail deposit pricing was just beginning to be widely available, we rely here on press and other primary sources’ descriptions from that era. In exploring why price differentiation grew in the 1980s and 1990s, we describe some of those factors, but we think of these as correlates, not proof of causality.

Through their exposure to short-term interest rates, money market mutual funds offered savers higher rates and greater protection against inflation than demand deposit accounts could offer, as they were subject to Regulation Q restrictions on the payment of interest. To compete, banks launched a high-interest account with limited transactions allowed per month, the NOW Account (Negotiated Order of Withdrawal). These products were approved for rollout nationwide in 1980 by an act of Congress and a 5 percent interest rate cap was lifted in 1986.

These products were widely popular with customers, but much less profitable on average than checking accounts had previously been. In the years following the introduction of the NOW account, banks searched for ways by which they could still offer interest on checking accounts without losing revenue. Banks instituted higher fees on lower balance customers and relatively high account minimums to ensure break-even for this new product. These balances (typically ranging on the order of $1,000 minimum balance at commercial banks, and around $300 at thrifts, such as savings banks and S&Ls) were publicly justified by bankers arguing that higher minimum balances reflected the increased break-even point on interest-paying deposits.

There was extensive writing about these new accounts both within the press and in the burgeoning industry of saver-oriented consumer reporting. In 1983, the New York Times reported that account fees had more than doubled since the start of the decade and minimum balances for fee waivers, as high as $2,500 in some local markets, had been introduced. A few years later, Sheshunoff, a leading publisher of deposit product comparisons, reported that transaction fees on checking accounts nearly doubled yet again in many of the markets it covered between 1985 and 1988.

In parallel, as changes in the deposit market intensified, mutual banks came under a long and painful period of financial stress on their lending portfolios. The causes and impacts of the waves of bank failures triggered by the Savings and Loan Crisis are covered in an extensive literature of their own. Many mutuals failed, converted, or were acquired in this period, but their deposits and branch infrastructure still made them attractive acquisition targets.

Throughout the 1980s and early 1990s, through both voluntary and arranged mergers, struggling mutuals were among the first retail players to be consolidated in the two and a half decades of retail banking consolidation that followed. The loss of the mutuals reduced the options available to low-balance customers, particularly in the regional markets of the northeast where they had historically been strongest. Mutuals tended to have lower minimum balance requirements and lower fees. Studies from the period also show that commercial banks with large branch networks also tended to pay lower rates on deposits than either community banks or mutuals did.

Due in no small part to increased computing power and growing sophistication in cost-accounting, customer-level profit segmentation became a lens through which banks have looked at retail customers, not only in banking but across a wide range of industries since the late 1980s. Banks needed to know what products to target at which customers and where the break-even points would be on each product, leading to changes in the way retail banks were managed at the customer level. A bibliography of some of this literature can be found here.

With profitability segmentation, bank clients could be divided into “A,” “B,” and “C” tiers (“A” being the most potentially lucrative, but the terms will vary by firm) based on current balances and potential future profit. Higher balance “A” customers tend to cover more than their allocated share of bank expenses and make a large contribution to bank profits; customers in the “B” and “C” tiers tend to make a marginal or negative contribution. Consequently, lower tier clients saw an increase in account service and overdraft fees, so that they would be more profitable on a stand-alone basis. In more recent years, higher overdraft charges have continued this trend of imposing fees to make lower-balance customers more profitable.

There may be signs of change in the market. Fintech firms are increasingly offering low-cost checking account options in a marketplace less tied to costly brick-and-mortar infrastructure. As of this posting, some major banks have also begun announcing an end to some or all overdraft fees on retail accounts (although other fees will likely stay in place). This may or may not be a longer-term trend, but it would go some way toward addressing one of the most clear-cut cases of product pricing impacting low-balance customers.

The following post in this series will dive more deeply into the dynamics of account overdraft fees and their implications for inequality.

Summing Up
The great repricing of bank products that began four decades ago has been associated with profound changes in financial inclusion. Compared to that earlier era, there are fewer institutions offering low-minimum, low-fee accounts and retail deposit and transaction products are more differentiated based on balances, with the associated fees hitting lower-balance customers hardest. As a result, a substantial number of low- and middle-income consumers choose to be unbanked to avoid fees, a figure that rises when the economy is not performing well. Loss of access to a transaction account can have knock-on effects in terms of inequality, particularly through the mechanism of credit access, banking relationships, and credit histories. Greater availability of low-cost checking accounts, by this logic, would translate into higher rates of inclusion in what is arguably the cornerstone product for inclusion in the economy.

If the past is prelude, this leads us to think about alternative futures. Will traditional banks increasingly forego fees and allow greater cross-subsidization between customer segments? As many credit unions offer increasingly liberal terms for membership, will they help fill the gap for financial inclusion? Alternatively, will technology fill the void, enabling banks or fintechs to serve clients that are currently high-cost much more cheaply so that there are very few “C” customers left? Or perhaps, as was the case a century ago, it is time for mission-driven organizations to think again about mutual banking?

Stein BerreStein Berre is a senior vice president in the Federal Reserve Bank of New York’s Supervision Group.

Kristian BlickleKristian Blickle is an economist in the Bank’s Research and Statistics Group.

Rajashri ChakrabartiRajashri Chakrabarti is a senior economist in the Bank’s Research and Statistics Group.

How to cite this post:
Stein Berre, Kristian Blickle, and Rajashri Chakrabarti, “Banking the Unbanked: The Past and Future of the Free Checking Account,” Federal Reserve Bank of New York Liberty Street Economics, June 30, 2021, https://libertystreeteconomics.newyorkfed.org/2021/06/banking-the-unbank....
Additional Posts in this Series
Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion
Credit, Income, and Inequality

Related Reading
Once Upon a Time in the Banking Sector: Historical Insights into Banking Competition
The ‘Banking Desert’ Mirage
Economic Inequality: A Research Series

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Devolving money creation

Published by Anonymous (not verified) on Tue, 27/07/2021 - 9:18pm in

There is an interesting programme from Renegade Inc (27 minutes) with the South African, Brett Scott who is ‘an author and financial activist’. I suggest that he has various insights: First that the cashless society is definitely not for the benefit of individuals but rather for corporations and banks. Second the ‘war on cash’ is... Read more

Keeping Borrowers Current in a Pandemic

Published by Anonymous (not verified) on Tue, 27/07/2021 - 5:56am in

Andrew Haughwout, Donghoon Lee, Joelle Scally, and Wilbert van der Klaauw

Keeping Borrowers Current in a Pandemic

Federal government actions in response to the pandemic have taken many forms. One set of policies is intended to reduce the risk that the pandemic will result in a housing market crash and a wave of foreclosures like the one that accompanied the Great Financial Crisis. An important and novel tool employed as part of these policies is mortgage forbearance, which provides borrowers the option to pause or reduce debt service payments during periods of hardship, without marking the loan delinquent on the borrower’s credit report. Widespread take-up of forbearance over the past year has significantly changed the housing finance system in the United States, in different ways for different borrowers. This post is the first of four focusing attention on the effects of mortgage forbearance and the outlook for the mortgage market. Here we use data from the New York Fed’s Consumer Credit Panel (CCP) to examine the effects of these changes on households during the pandemic.

Background: Who Qualifies for COVID-19 Mortgage Forbearance?

Initially, under the CARES Act, borrowers with federally backed mortgages could request up to twelve months of forbearance, made up of two 180-day periods, if they experienced financial hardship because of COVID-19. Several agencies have subsequently granted extensions. Specifically, borrowers with mortgages backed by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac can request up to two additional three-month extensions (for a maximum of eighteen months of total forbearance) if they were in an active forbearance plan as of February 28, 2021, while borrowers with mortgages backed by the Department of Housing and Urban Development/Federal Housing Administration (HUD/FHA), the U.S. Department of Agriculture (USDA), or the Department of Veterans Affairs (VA) can enroll in forbearance until June 30, 2021, and receive up to eighteen months of total forbearance. At the same time, the CARES Act (section 4013) eased the accounting treatment of pandemic-related modifications for loans in bank portfolios, and the federal banking agencies released guidance to that effect in early April 2020.

How Does Forbearance Work?

Widespread forbearance is a new policy, although similar programs have previously been rolled out on a smaller scale in the wake of natural disasters. Typically, the missed payments will be added to the end of the loan; for a borrower in the first year of a thirty-year mortgage, a forbearance thus amounts to a twenty-nine-year interest-free loan of the forborne amount. These forbearances are safe loans in part because they are incentive-compatible: in order to preserve their housing equity, borrowers must resume payments when they are able. (Note that renters, with no equity in their property, do not have strong incentives to pay back forborne rent payments, making the provision of relief to renters more difficult than to owners.)

Who Entered Forbearance?

As we reported back in November, large numbers of mortgage forbearances began to appear on credit reports in April 2020, and by May 2020, 7 percent of mortgage accounts were in forbearance. By June, however, exits from forbearance began to outweigh entries, and the number of mortgages in forbearance began a slow decline. The following chart shows that by March 2021, the overall forbearance rate had fallen to 4.2 percent, accompanied by reductions in both entries and exits, suggesting a relatively stable group of borrowers in forbearance for a relatively long period of time. In fact, of the 2.2 million mortgages still in forbearance in March 2021, 1.2 million entered forbearance in June 2020 or earlier. (In March, the inflows into forbearance are likely affected by additional payment relief offered in Texas as a response to the effects of the winter storm there.)

Keeping Borrowers Current in a Pandemic

These dynamics—a sharp rise in April and May, followed by a slow decline through the summer and fall—are common across most types of mortgages, but FHA borrowers were considerably more likely to take up mortgage forbearance initially, and have remained in the program longer. As of March 2021, more than 11 percent of FHA borrowers remain in forbearance, as shown below.

Keeping Borrowers Current in a Pandemic

What accounts for the higher forbearance rates for FHA borrowers? FHA borrowers are much more likely to be first-time home buyers and to live in lower-income areas. About 41 percent of FHA borrowers live in neighborhoods with average annual household income below $50,000, compared to 22 percent for GSE borrowers.

With this context, it’s perhaps not surprising to find that forbearance rates rose most, and were most persistent, in lower average income zip codes. As shown in the next chart, forbearance rates in the poorest quartile of zip codes approached 10 percent in May and June 2020 and remain above 5.5 percent at the end of March 2021.

Keeping Borrowers Current in a Pandemic

The likelihood of forbearance falls steadily as borrower credit score (measured at the date of mortgage origination) rises, and it is far higher for loans that were delinquent in March 2020; see the next chart. Indeed, forbearance rates remain near 40 percent for borrowers who were delinquent on their mortgages pre-pandemic. The higher rates of mortgage forbearance in poorer areas and among FHA borrowers is consistent with the uneven impact that COVID-19 and the accompanying recession have had on different segments of the population. Mortgage forbearance has been an important policy tool to mitigate the impact of these challenges faced by less-advantaged households.

Keeping Borrowers Current in a Pandemic

Since housing costs are typically one of the largest household expenses, it isn’t surprising that mortgage forbearance offers very substantial cash flow relief to the households that take it up. The table below provides details on the payment relief that different forbearance participants received. (As we show in a companion post, being enrolled in forbearance isn’t quite the same as receiving cash flow relief.) We estimate this relief using the average payment that was due prior to enrolling in forbearance for those who were enrolled in forbearance as of March 2021. (These figures have been very stable since March 2020, so we don’t show the changes over time here.)

Keeping Borrowers Current in a Pandemic

As the table shows, the average monthly cash flow relief associated with a mortgage forbearance is somewhat different across different mortgage types and grows sharply as neighborhood income rises. Indeed, aggregate cumulative payments skipped by borrowers from the poorest 25 percent of neighborhoods are about 38 percent of those skipped in top-quartile neighborhoods.

All told, in absolute dollar terms, mortgage forbearance has brought the most benefit to the highest-income areas. This is due to a combination of high homeownership and relatively expensive mortgage payments in these areas, which more than offsets the considerably higher incidence of forbearance in lower-income areas. Still, the high rates of forbearance take-up on FHA loans and in poorer zip codes makes clear that these programs have been an important lifeline to less-advantaged households.

Conclusion

We find that mortgage forbearance has been an important policy tool to mitigate the impact of the pandemic and has become a fairly common phenomenon since it became widely available last year. After an initial rapid rise to over 7 percent, the share of mortgages in forbearance has slowly declined and stood at just over 4 percent in late March 2021. Forbearance has been more common for FHA borrowers and mortgagors from poorer neighborhoods, as well as those who were already delinquent in March 2020. In a separate post, we look at how being in forbearance affects borrowers, and continue to look at the distribution of those effects.

Andrew F. HaughwoutAndrew F. Haughwout is a senior vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Donghoon LeeDonghoon Lee is an officer in the Bank’s Research and Statistics Group.

Joelle ScallyJoelle Scally is a senior data strategist in the Bank’s Research and Statistics Group.

Wilbert van der KlaauwWilbert van der Klaauw is a senior vice president in the Bank’s Research and Statistics Group.

How to cite this post:

Andrew F. Haughwout, Donghoon Lee, Joelle Scally, and Wilbert van der Klaauw, “Keeping Borrowers Current in a Pandemic,” Federal Reserve Bank of New York Liberty Street Economics, May 19, 2021, https://libertystreeteconomics.newyorkfed.org/2021/05/keeping-borrowers-....

Additional Posts in This Series

What Happens during Mortgage Forbearance?

Small Business Owners Turn to Personal Credit

What’s Next for Forborne Borrowers?

Related Reading
Economic Inequality: A Research Series

Press Briefing

Keeping Borrowers Current in a Pandemic

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion

Published by Anonymous (not verified) on Thu, 15/07/2021 - 5:28am in

Jennifer Dlugosz, Brian Melzer, and Donald P. Morgan

 Overdrafts, Fee Caps, and Financial Inclusion

The 25 percent of low-income Americans without a checking account operate in a separate but unequal financial world. Instead of paying for things with cheap, convenient debit cards and checks, they get by with “fringe” payment providers like check cashers, money transfer, and other alternatives. Costly overdrafts rank high among reasons why households “bounce out” of the banking system and some observers have advocated capping overdraft fees to promote inclusion. Our recent paper finds unintended (if predictable) effects of overdraft fee caps. Studying a case where fee caps were selectively relaxed for some banks, we find higher fees at the unbound banks, but also increased overdraft credit supply, lower bounced check rates, and more low-income households with checking accounts. That said, we recognize that overdraft credit is expensive, sometimes more than even payday loans. In lieu of caps, we see increased overdraft credit competition and transparency as alternative paths to cheaper deposit accounts and increased inclusion.


Bouncing Out
Everyone by now understands the importance of a solid credit score, but the parallel world of debit scores is less familiar. When depositors are unable or unwilling to repay overdraft loans and fees, banks close their account and report their deposit history to a third-party debit bureau such as ChexSystems. Closing the account can stem future credit losses but not past ones; the average loss to banks per closed account is about $310 and such losses accounted for 12.6 percent of gross loan losses (FDIC 2008). A low debit score due to unpaid overdrafts follows the depositor, so they may be blocked from opening an account at another bank. As the authors of a (rare) study of account closings conclude: “…customers that bounce too many checks can find themselves bounced out of the banking system.”

Bouncing in with Fee Caps?
As a way to lower deposit costs and promote inclusion, Federal legislators recently introduced bills to limit or otherwise constrain overdraft fees: the Overdraft Protection Act of 2019 and the Stop Overdraft Profiteering Act of 2018. Although we agree that costly overdrafts drive vulnerable depositors from the banking system, economic principles suggest how a fee cap might go wrong. Overdraft coverage is credit for a fee so a fee cap amounts to a usury limit and lenders are well known to shun (“ration”) riskier borrowers under usury limits (e.g., Rigbi, 2013). Banks didn’t start offering credit cards in very large numbers, for example, until they found a loophole around state usury limits and could charge higher rates. If overdraft credit is like other credit, a fee cap would make banks be less willing to cover overdrafts and less willing to open accounts from depositors with low debit scores. Less overdraft credit and more bounced checks could, by increasing the cost of accounts to depositors, cause more not fewer unbanked households.

A Fee Cap “Experiment”
To investigate that possibility, we study a case where fee ceilings were selectively relaxed for some banks. In 2001, nationally chartered banks were effectively exempted from fee caps imposed by four states. That makes a good natural experiment because the “treatment” (the exemption) came at the Federal level, thus mitigating concerns that state conditions were driving it. It also helps that not all states had limits because we can compare outcomes at national banks versus others after the exemption in states with limits and without. Using that strategy and various data, we produce three main findings.

Higher Fees but More Credit
We find firstly that national banks raised fees about $2.50 (current dollars) relative to other banks after the exemption (see below, left panel). That shows fee caps do work to lower fees. However, we also find that national banks were more willing to cover overdrafts at the higher price (below, right panel). Relative to the average before the exemption, the fraction of national banks willing to cover overdrafts for a fee (rather than refusing outright) rose about 17 percent relative to the control.

 Overdrafts, Fee Caps, and Financial Inclusion

Fewer Bounced Checks
All else equal, more overdraft coverage implies fewer bounced checks (some banks call their overdraft programs “bounce protection”). We test that prediction using Fed check processing center (CPC) data. The Fed operated forty-six CPCs in 2000, with six in states that capped fees. Comparing CPCs in those states to others, we find returned check rates (per checks processed) declined about 15 percent after the exemption. That converts to about 1.7 million fewer bounced checks at those six CPCs per quarter and a substantial savings to check writers for insufficient funds (NSF) fees to merchants.

NSF fees are the twin to overdraft fees; they’re the fees charged when banks refuse to cover a check. Bank NSF and overdraft fees are about equal so the savings to depositors when banks do cover the check are on the NSF fee not owed to the merchant that accepted the check. Merchants’ NSF fees can (legally) rival banks, so avoiding two $30 NSF fees in exchange for a $30 overdraft fee saves the depositor $30, not to mention the embarrassment and stigma of bouncing a check. The benefit from bounced check protection (in the strict sense) is so clear that banks can cover checks without formal opt-in by depositors (electronic overdrafts, by contrast, require opt-in).

 Overdrafts, Fee Caps, and Financial Inclusion

By preserving check acceptance and thus account value, bounce protection might prevent vulnerable depositors from bouncing out. Even the friendliest “local” merchant will eventually reject checks from people who bounce too many or take too long to settle. That feedback could make account ownership by lower income households unstable; if a shock causes a bunch of bad checks and reduced check acceptance, the account becomes essentially worthless. The household may close it or wait until it is closed due to unpaid NSF fees. That dynamic suggests more banked households after
the fee cap exemption.

Using Census (SIPP) data, we observe just that. We find that the share of low-income households with checking accounts increases about 11 percent relative to other states after the fee cap exemption.

 Overdrafts, Fee Caps, and Financial Inclusion3

Better Off Unbanked?
Behavioral economists might challenge whether households are necessarily better off banked with access to overdraft credit. If overdraft costs are “shrouded,” newly banked households might eventually bounce out again once they realize the true costs. We have two findings to the contrary. First, bounced check rates don’t bounce back after fee caps are relaxed, suggesting continued savings on NSF fees. Second, as shown above, the share of low-income households that are banked remains elevated through the sample period and we don’t find (in a separate result) that they lose accounts (bounce out) at a higher rate after the change.

Takeaways
One discussant of our paper took us to mean that high overdraft fees were good for depositors; we are not saying that. Obviously, it would be better for depositors if the same credit were available at a lower price, but fee caps evidently don’t accomplish that. Increased transparency and competition—nature’s price cap—may be a better way to bring overdraft fees in line with costs and risk. Banks are known to increase overdraft credit when forced to compete with payday lenders (Melzer and Morgan) but competition among overdraft providers is unstudied. The virtual non-existence of advertising of overdraft credit suggests that inter-bank competition is weak. Emerging financial technology firms might also strengthen the state of play, particularly if they can provide real-time balance information that enables depositors to know on the spot if a transaction will cause a negative balance, and if so, whether they want credit. Finally, our findings are notable in light of recent public declarations by a few banks that they will cease charging overdraft fees. The trade-off we identify suggests that banks operating under a hard, self-imposed fee cap may be less willing to allow overdrafts, cover checks, and accept deposits from households prone to overdrafts.

Jennifer Dlugosz is a principal economist at the Federal Reserve Board.

Brian Melzer is an associate professor at Dartmouth Tuck School of Business.

Donald P. MorganDonald P. Morgan is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

How to cite this post:
Jennifer Dlugosz, and Brian Melzer, and Donald P. Morgan, “Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion,” Federal Reserve Bank of New York Liberty Street Economics, June 30, 2021, https://libertystreeteconomics.newyorkfed.org/2021/06/hold-the-check-ove....

Additional Posts in this Series
Banking the Unbanked: The Past and Future of the Free Checking Account
Credit, Income, and Inequality

Related Reading
Who Pays the Price? Overdraft Fee Ceilings and the Unbanked (Staff Report)
Economic Inequality: A Research Series

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Haiti: The Trail of Blood That Leads Back to The U.S.

Published by Anonymous (not verified) on Thu, 15/07/2021 - 4:41am in

Critical Hour hosts Garland Nixon and Wilmer Leon talk to Palast about the recent assassination of Haiti’s president, Jovenel Moïse, and the trail of blood that leads back to the United States. The trio also discuss the socioeconomic background against which this murder occurred, and how the economy of this mineral and agriculturally rich Caribbean nation has been systematically stripped — and, to this end, its stability and security systematically undermined — by multinational corporations backed by ... READ MORE

Tailoring Regulations

Published by Anonymous (not verified) on Tue, 13/07/2021 - 12:06am in

Rebecca Reubenstein and Asani Sarkar

Regulations are not written in stone. The benefits derived from them, along with the costs of compliance for affected institutions and of enforcement for regulators, are likely to evolve. When this happens, regulators may seek to modify the regulations to better suit the specific risk profiles of regulated entities. In this post, we consider the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) passed by Congress in 2018, which eased banking regulations for smaller institutions. We focus on one regulation—the Liquidity Coverage Ratio (LCR)—and assess how its relaxation affected newly exempt banks’ assets and liabilities, and the resilience of the banking system.

Economic Growth, Regulatory Relief, and Consumer Protection Act
In response to the financial crisis of 2008, the Federal Reserve strengthened prudential regulation of large banks, including implementing Section 165 of the Dodd-Frank Act, which required the Fed to establish stricter prudential standards for bank holding companies (“banks”) with total consolidated assets of $50 billion or more. Later, regulators indicated that the asset size threshold might be too low, as the Dodd-Frank Act applied to smaller institutions that did not pose a threat to financial stability but still faced burdensome compliance costs. In November 2017, the Senate Banking Committee reached an agreement on a bill to increase the asset threshold for prudential regulations.

The EGRRCPA, enacted May 24, 2018, provided that, effective immediately, banks with assets less than $100 billion were not subject to Section 165. Shortly thereafter, on July 6, 2018, the Fed issued a statement saying that it would not take action to require exempt banks to comply with certain existing regulatory requirements, such as the LCR. In motivating the changes, the Fed said the exempt banks typically have stable sources of funding, simple business models, and little, if any, foreign exposures, and therefore pose less of a concern for financial stability than larger banks.

The Liquidity Coverage Ratio
The LCR, finalized in 2013, requires banks to maintain enough high-quality liquid assets (HQLA) to cover their net cash outflows for thirty days during a period of stress. It originally applied to large and internationally active banks with consolidated assets of at least $50 billion. Among banks subject to the LCR, those with assets between $50 billion and $250 billion (“modified LCR banks”) were subject to a less stringent form of the LCR compared to larger banks.

Possible Bank Responses to Exemption from LCR
The LCR incentivizes banks to hold liquid assets, which can be quickly exchanged for cash in a crisis, and provides a disincentive for them to hold “runnable” liabilities, which can be easily withdrawn and thus result in greater short-term cash outflows. Consistent with this interpretation, lending by affected U.S. banks decreased, relative to unaffected banks, following the finalization of the LCR.

For banks that became exempt from the LCR, one might then expect a reverse effect—that is, these banks might lend more and borrow more using runnable liabilities. Lending could be further encouraged since the Fed also relaxed certain capital regulations, such as stress tests. However, if exempt banks were not constrained by the LCR—for example, if their LCR levels were much higher than required (as was the case for one bank)—then we might not observe large changes in their balance sheets. In addition, some analysts argued that the rule changes were too small to have meaningful effects on bank balance sheets.

For our analysis, we compare modified LCR banks that became exempt from the rule (“exempt banks”) with other modified LCR banks that did not (“non-exempt banks”). Modified banks are similar in size, allowing us to better identify tailoring effects. We consider balance sheet changes around the fourth quarter of 2017, when the agreement to tailor LCR was reached, and around the second quarter of 2018 through the third quarter of 2018, when the law passed and took effect.

As of the third quarter of 2017, there were twenty-six modified LCR banks, but we exclude seven banks that lacked data for every quarter or transitioned between the exempt and non-exempt groups during our sample period. Of the remaining nineteen banks, only four became exempt from LCR. The small number of exempt banks likely mitigates any potentially adverse effects from the regulatory changes on the banking sector, while also making it difficult to draw strong conclusions from our data.

Bank Borrowing and Lending
Did newly exempt banks increase their borrowing using runnable liabilities relative to non-exempt banks? Overnight debt is considered runnable, but for exempt banks, the amount of overnight federal funds and repo funding is less than 0.5 percent of assets. However, deposits are a large source of funding for exempt banks. Certain types of retail transaction deposits are treated more favorably in the LCR relative to other deposits. Over our sample, transaction deposits fall by a modest amount (as a share of total deposits) for exempt banks while those of non-exempt banks change little. At the same time, the share of money market deposits and other savings accounts—also generally considered stable funding in the LCR—increases moderately for exempt banks relative to non-exempt banks. Overall, exempt banks’ runnable liabilities do not appear to change much relative to non-exempt banks following tailoring.

Turning to loans, the chart below shows that loans as a share of assets held by exempt banks increase by about 2 percentage points from the third quarter of 2017 to the fourth quarter of 2018 but then revert to pre-tailoring levels. The share of loans by non-exempt banks also increases by about 1 percentage point during the period, suggesting that some of the observed change in loan shares may be unrelated to the regulatory change. The stability of lending patterns also holds for specific loan types such as commercial and industrial loans and real estate loans.

To provide a summary assessment of changes in banks’ balance sheets, we examine their liquidity transformation activities (in other words, funding illiquid assets with liquid liabilities)—a key function of banks. Using a measure of liquidity creation utilizing items both on and off banks’ balance sheets, we find little change in liquidity creation by exempt or non-exempt banks following tailoring.

Bank Risk and Resilience
Some analysts expressed concern that exempt banks might reduce their liquid assets and that their probability of failure would thereby increase. Indeed, exempt banks’ holdings of HQLA as a share of total assets declined—relative to that of non-exempt banks—by about 5 percentage points between the third quarter of 2017 and the third quarter of 2018 but then partially bounced back, ending 2019 down by about 3 percentage points, as shown in the chart below. Thus, the decrease in HQLA appears to have been moderate and temporary.

More than individual bank risk, the LCR is designed to increase the resiliency of the banking sector. As exempt banks are smaller and less systemically important than non-exempt banks, their losses are less likely to spill over to other institutions. In this New York Fed Staff Report, the authors measure fire-sale risk, or the risk of spillover losses among banks caused by asset fire sales under hypothetical stress scenarios. Using the authors’ measure, we find little evidence that exempt banks’ contributions to fire-sale risk, as a share of their total assets, increased relative to non-exempt banks, as shown in the chart below.

Final Words
We examine a regulatory change that exempted a small number of banks from banking regulations, including the LCR, to better align the regulations to the specific risks of affected entities. Following the relaxation, we find few changes in lending and short-term borrowing of exempt banks or in the resilience of the banking sector. To be sure, analyzing the effects of regulatory changes is challenging, because few firms may be affected (as in our analysis) or because the effects may occur over several years. As bank regulations continue to evolve (for example, they were revised again in November 2019), evaluating the costs and benefits of such changes remains an ongoing task.

Rebecca Reubenstein is a senior research analyst in the Federal Reserve Bank of New York’s Research and Statistics Group.

Asani SarkarAsani Sarkar is an assistant vice president in the Bank’s Research and Statistics Group.

How to cite this post:
Rebecca Reubenstein and Asani Sarkar, “Tailoring Regulations,” Federal Reserve Bank of New York Liberty Street Economics, July 12, 2021, https://libertystreeteconomics.newyorkfed.org/2021/07/tailoring-regulations.
Related Reading
Fire-Sale Spillovers and Systemic Risk
Bank Liquidity Creation, Systemic Risk, and Basel Liquidity Regulations
Did Banks Subject to LCR Reduce Liquidity Creation?

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Nestle, Pinkwashing and the Corporate Enslavement of Black Africans

Apart from the mad internet radio host, Alex Belfield, another right wing YouTube channel I keep an eye on is The Lotus Eaters, with Sargon of Gasbag, alias Carl Benjamin, and his friends. It annoys me with its calm assumption that capitalism is perfect, more privatisation and deregulation will lift the world’s starving billions out of poverty and their casual sneers against the left. I found their review of Ze’ev Sternhell’s latest book on Fascism, Neither Left Nor Right, absolutely unwatchable because of the massive amount of ignorance about the subject, and just intellectual history generally. Sternhell’s an Israeli who grew up in Poland during the Nazi invasion. He’s a very well respected scholar of Fascism, not surprisingly. But Benjamin and his cronies took the book as proving that Fascism is a form of socialism. This idea is rampant on the right. This ignores the Fascist alliance with big business, their promotion of capitalism, and their recruitment of private sector businessmen to run the vast industrial associations through which the Nazis exercised control of industry and society. Mussolini started out as a radical socialist, but moved right to ally with the industrialists and feudal landlords to break up the socialist trade unions, smash workers’ and peasants’ cooperatives, and destroy other dangerous liberal political parties, like the Populists. The Italian Popular party was founded as a Catholic organisation, and stood for a widening of democracy including the radical step of votes for women and further rights for the workers and peasants. But the papacy at the time allied with the Fascists to smash it because it wasn’t under the control of the bishops. Yes, Mussolini’s ideal of the corporative state, in which industries are run by vast industrial associations which combine the trade unions with the employer’s organisations, sort of if someone combined the Confederation of British Industry and the Trades Union Congress and then gave them a separate parliamentary chamber, was derived from anarcho-syndicalism. But it also incorporated ideas from Nationalists like Alfredo Rocco, who wanted the state to take over the trade unions from a right-wing, pro-business viewpoint. It also ignores Adolf Hitler’s adulation of the big businessman as biologically superior to the proles, his blanket refusal to nationalise anything and a speech he made to the German version of the CBI stating that business needed dictatorship to protect it. Instead you generally get a lot of waffle about how the Nazis were socialists, because they said so, but it and Fascism were different types of socialism to Communism. In fairness, this analysis of Italian Fascism does have more than an element of truth. In the words of Sargon’s matey Callum, Fascism is socialism after it dumps Communism. Which is almost true, but ignores the fact that Communism is only one form of socialism, and was so even at the time. But it excludes the fact that Mussolini and the rest were generally and fanatically pro-capitalist. The statement that it must somehow be a form of socialism rests on the Fascist’s state control of industry. But this state control is contrasted with an idealised form of free market capitalism that has never existed. And Fascist corporativism looks very much like the Blairite Third Way or modern neoliberalism, in which the heads of big corporations form government policy and and are rewarded with government posts.

It looks like Boris Johnson’s crony capitalism, and is, I fear, what we are moving towards with his continued attack on democracy and the right to protest.

However, I believe very strongly that the Lotus Eaters are absolutely right about the extremist views promoted by the far left, like Black Lives Matter and Critical Race Theory. So do many left-wing intellectuals, who feel that there is still a lot of racism, sexism and bigotry that needs to be tackled, but despise Critical Race Theory and Queer Theory for their rejection of objective truth and fact in favour of feelings, ideological assumptions and subjective interpretations.

It was the end of Pride Month a few days ago, and the Lotus Eaters marked the occasion by sneering at the corporate nonsense various big companies were putting out to show that they indicated Pride and gay and trans rights. I’m blogging about this not because I wish to attack genuine support for gay rights or promote intolerance towards trans people, but because some of this corporate support does seem a mite excessive. And in some cases it might even be hypocritical. The Lotus Eaters’ video included a promo video from one of the banks telling everyone to watch their pronouns around trans people. Ikea went even so far as to launch gay and trans sofas. The gay sofa has various colour straps running across it, presumably to represent the colours of the rainbow gay flag. The trans sofa has various slogans written on it, one of which is ‘No-one will believe you.’ The sofa is also decorated with prints of multicoloured hands. Various trans people appear in the video saying that they can really express their essential selves on this piece of furniture. Which makes it sound like no trans person was ever comfortable on a normal sofa before. Sargon and Callum then giggle about how the hands and slogan make the sofa creepily rape-y, and unfortunately they do have a point.

But they have a rather more serious point when they report that a legal suit brought against Nestle, one of the companies loudly promoting their support of gay and trans right, was thrown out last week by an American court. The suit was against the company’s use of enslaved Black African labour in the production of the cocoa from which their chocolate is made. The case was thrown out because the people enslaved aren’t under American jurisdiction. Sargon and Callum used it to argue that Nestle, and all the other companies, really don’t care about the various left-wing issues they claim to support, like Black Lives Matter. They just want to be seen as nice, liberal and cuddly to avoid being attacked for racism or any other form of bigotry. And in the case of gay rights, it’s called ‘pinkwashing’.

Israel’s particularly guilty of this, using the state’s official tolerance towards gay culture and the Jerusalem Pride parade to present a false liberalism and appeal to western liberals and radicals against Islam. Israel is pro-gay, even though many of its citizens are extremely conservative in their views and hate gays just like they’re hated by other religions and societies. They contrast this with the persecution of gays in contemporary Islam. But traditionally Islam was far more tolerant of homosexuality. Tele Sur’s Abbie Martin reported that when she went to Palestine, she found the situation the complete opposite of what the Israelis were claiming. Gayness was definitely tolerated, and she saw gay couples who were not persecuted at all.

Nestle’s a nasty corporation. I remember the scandal a few years ago when they were pushing their baby milk, a substance that needed to be bought after the baby was started on it, as against healthy breastfeeding in Africa. And all for corporate profit. It doesn’t surprise me that they source their cocoa from plantations using slave labour. It also bears out a comment by one of the great readers of this blog, who pointed me in the direction of an article about how the various big companies all pledging their support for Black Lives Matter were ruthless exploiters of slave, or starvation level labour in the developing world. This is all lies and corporate hypocrisy, done to impress liberal consumers in the West, while the reality is very different.

I’ve also no doubt that the example he makes of Nestle using Black African slave labour also damages his case for unrestrained capitalism. This is what unrestrained private enterprise looks like. The most horrific example of this was the Belgian Congo, now Zaire, when it was the personal fief of the Belgian king, Leopold. Leopold set up his own private police force, the Force Publique, and demanded that all Congolese produced a set amount of rubber. If they didn’t, they were beaten, mutilated and killed. Eight million Congolese died in what can only justly be described as a holocaust. This is what unrestrained global capitalism is doing today – forcing people into real slavery and poverty. We need more regulation, not less.

And I’m dam’ sure that the case against Nestle was brought by lefties outraged at this corporate enslavement for a western multinational.

Don’t be taken in by this type of false advertising, which only really applies to the West. We needed to see beyond the specious support some companies give to liberal issues like anti-racism and gay rights, and look at what is really going on elsewhere in the world.

If you want to have a look at their video, it’s entitled ‘Social Justice Is Going Over the Top’ and it’s at (2) Social Justice is Going Over the Top – YouTube. I’m not going to post it, just link to it, because, well, this is Sargon of Gasbag, the man who broke UKIP, and the Lotus Eaters are annoying, even when they make some decent points people on the left can also get behind.

Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion

Published by Anonymous (not verified) on Wed, 30/06/2021 - 9:02pm in

Jennifer Dlugosz, Brian Melzer, and Donald P. Morgan

     Overdrafts, Fee Caps, and Financial Inclusion

    The 25 percent of low-income Americans without a checking account operate in a separate but unequal financial world. Instead of paying for things with cheap, convenient debit cards and checks, they get by with “fringe” payment providers like check cashers, money transfer, and other alternatives. Costly overdrafts rank high among reasons why households “bounce out” of the banking system and some observers have advocated capping overdraft fees to promote inclusion. Our recent paper finds unintended (if predictable) effects of overdraft fee caps. Studying a case where fee caps were selectively relaxed for some banks, we find higher fees at the unbound banks, but also increased overdraft credit supply, lower bounced check rates, and more low-income households with checking accounts. That said, we recognize that overdraft credit is expensive, sometimes more than even payday loans. In lieu of caps, we see increased overdraft credit competition and transparency as alternative paths to cheaper deposit accounts and increased inclusion.

    Bouncing Out

    Everyone by now understands the importance of a solid credit score, but the parallel world of debit scores is less familiar. When depositors are unable or unwilling to repay overdraft loans and fees, banks close their account and report their deposit history to a third-party debit bureau such as ChexSystems. Closing the account can stem future credit losses but not past ones; the average loss to banks per closed account is about $310 and such losses accounted for 12.6 percent of gross loan losses (FDIC 2008). A low debit score due to unpaid overdrafts follows the depositor, so they may be blocked from opening an account at another bank. As the authors of a (rare) study of account closings conclude: “…customers that bounce too many checks can find themselves bounced out of the banking system.”

    Bouncing in with Fee Caps?

    As a way to lower deposit costs and promote inclusion, Federal legislators recently introduced bills to limit or otherwise constrain overdraft fees: the Overdraft Protection Act of 2019 and the Stop Overdraft Profiteering Act of 2018. Although we agree that costly overdrafts drive vulnerable depositors from the banking system, economic principles suggest how a fee cap might go wrong. Overdraft coverage is credit for a fee so a fee cap amounts to a usury limit and lenders are well known to shun (“ration”) riskier borrowers under usury limits (e.g., Rigbi, 2013). Banks didn’t start offering credit cards in very large numbers, for example, until they found a loophole around state usury limits and could charge higher rates. If overdraft credit is like other credit, a fee cap would make banks be less willing to cover overdrafts and less willing to open accounts from depositors with low debit scores. Less overdraft credit and more bounced checks could, by increasing the cost of accounts to depositors, cause more not fewer unbanked households.

    A Fee Cap “Experiment”

    To investigate that possibility, we study a case where fee ceilings were selectively relaxed for some banks. In 2001, nationally chartered banks were effectively exempted from fee caps imposed by four states. That makes a good natural experiment because the “treatment” (the exemption) came at the Federal level, thus mitigating concerns that state conditions were driving it. It also helps that not all states had limits because we can compare outcomes at national banks versus others after the exemption in states with limits and without. Using that strategy and various data, we produce three main findings.

    Higher Fees but More Credit

    We find firstly that national banks raised fees about $2.50 (current dollars) relative to other banks after the exemption (see below, left panel). That shows fee caps do work to lower fees. However, we also find that national banks were more willing to cover overdrafts at the higher price (below, right panel). Relative to the average before the exemption, the fraction of national banks willing to cover overdrafts for a fee (rather than refusing outright) rose about 17 percent relative to the control.

     Overdrafts, Fee Caps, and Financial Inclusion

    Fewer Bounced Checks

    All else equal, more overdraft coverage implies fewer bounced checks (some banks call their overdraft programs “bounce protection”). We test that prediction using Fed check processing center (CPC) data. The Fed operated forty-six CPCs in 2000, with six in states that capped fees. Comparing CPCs in those states to others, we find returned check rates (per checks processed) declined about 15 percent after the exemption. That converts to about 1.7 million fewer bounced checks at those six CPCs per quarter and a substantial savings to check writers for insufficient funds (NSF) fees to merchants.

    NSF fees are the twin to overdraft fees; they’re the fees charged when banks refuse to cover a check. Bank NSF and overdraft fees are about equal so the savings to depositors when banks do cover the check are on the NSF fee not owed to the merchant that accepted the check. Merchants’ NSF fees can (legally) rival banks, so avoiding two $30 NSF fees in exchange for a $30 overdraft fee saves the depositor $30, not to mention the embarrassment and stigma of bouncing a check. The benefit from bounced check protection (in the strict sense) is so clear that banks can cover checks without formal opt-in by depositors (electronic overdrafts, by contrast, require opt-in).

     Overdrafts, Fee Caps, and Financial Inclusion

    By preserving check acceptance and thus account value, bounce protection might prevent vulnerable depositors from bouncing out. Even the friendliest “local” merchant will eventually reject checks from people who bounce too many or take too long to settle. That feedback could make account ownership by lower income households unstable; if a shock causes a bunch of bad checks and reduced check acceptance, the account becomes essentially worthless. The household may close it or wait until it is closed due to unpaid NSF fees. That dynamic suggests more banked households after
    the fee cap exemption.

    Using Census (SIPP) data, we observe just that. We find that the share of low-income households with checking accounts increases about 11 percent relative to other states after the fee cap exemption.

     Overdrafts, Fee Caps, and Financial Inclusion3

    Better Off Unbanked?

    Behavioral economists might challenge whether households are necessarily better off banked with access to overdraft credit. If overdraft costs are “shrouded,” newly banked households might eventually bounce out again once they realize the true costs. We have two findings to the contrary. First, bounced check rates don’t bounce back after fee caps are relaxed, suggesting continued savings on NSF fees. Second, as shown above, the share of low-income households that are banked remains elevated through the sample period and we don’t find (in a separate result) that they lose accounts (bounce out) at a higher rate after the change.

    Takeaways

    One discussant of our paper took us to mean that high overdraft fees were good for depositors; we are not saying that. Obviously, it would be better for depositors if the same credit were available at a lower price, but fee caps evidently don’t accomplish that. Increased transparency and competition—nature’s price cap—may be a better way to bring overdraft fees in line with costs and risk. Banks are known to increase overdraft credit when forced to compete with payday lenders (Melzer and Morgan) but competition among overdraft providers is unstudied. The virtual non-existence of advertising of overdraft credit suggests that inter-bank competition is weak. Emerging financial technology firms might also strengthen the state of play, particularly if they can provide real-time balance information that enables depositors to know on the spot if a transaction will cause a negative balance, and if so, whether they want credit. Finally, our findings are notable in light of recent public declarations by a few banks that they will cease charging overdraft fees. The trade-off we identify suggests that banks operating under a hard, self-imposed fee cap may be less willing to allow overdrafts, cover checks, and accept deposits from households prone to overdrafts.

    Jennifer Dlugosz is a principal economist at the Federal Reserve Board.

    Brian Melzer is an associate professor at Dartmouth Tuck School of Business.

    Donald P. MorganDonald P. Morgan is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

    How to cite this post:

    Jennifer Dlugosz, and Brian Melzer, and Donald P. Morgan, “Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion,” Federal Reserve Bank of New York Liberty Street Economics, June 30, 2021, https://libertystreeteconomics.newyorkfed.org/2021/06/hold-the-check-ove....

    Additional Posts in this Series

    Banking the Unbanked: The Past and Future of the Free Checking Account


    Credit, Income, and Inequality



    Related Reading

    Who Pays the Price? Overdraft Fee Ceilings and the Unbanked (Staff Report)


    Economic Inequality: A Research Series




    Disclaimer

    The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

    Banking the Unbanked: The Past and Future of the Free Checking Account

    Published by Anonymous (not verified) on Wed, 30/06/2021 - 9:00pm in

    Stein Berre, Kristian Blickle, and Rajashri Chakrabarti

     The Past and Future of the Free Checking Account

    About one in twenty American households are unbanked (meaning they do not have a demand deposit or checking account) and many more are underbanked (meaning they do not have the range of bank-provided financial services they need). Unbanked and underbanked households are more likely to be lower-income households and households of color. Inadequate access to financial services pushes the unbanked to use high-cost alternatives for their transactional needs and can also hinder access to credit when households need it. That, in turn, can have adverse effects on the financial health, educational opportunities, and welfare of unbanked households, thereby aggravating economic inequality. Why is access to financial services so uneven? The roots to part of this problem are historical, and in this post we will look back four decades to changes in regulation, shifts in the ownership structure of retail financial services, and the decline of free/low-cost checking accounts in the United States to search out a few of the contributory factors.

    The Unbanked

    The economics of banking do not incentivize the delivery of financial services to those who may need them most. Since profits at retail banks are driven heavily by the size of the balances their customers deposit or borrow, product offerings and marketing efforts are disproportionately focused on clients with higher levels of income and wealth. Checking accounts display the characteristics of a good that has a high degree of income elasticity for lower-income households. In other words, a checking account is a good that lower-income households may choose to forego if household budgets are tight (as during a spell of unemployment); meanwhile, checking accounts have near-universal penetration among wealthier households. For a subset of consumers, estimated by the FDIC in 2019 to be just over 5 percent of the population, basic account access remains lacking, particularly among those with irregular incomes, less documentation, and a lack of credit history.

    Significantly, almost half of this unbanked group previously had bank accounts and now choose not to have one. Reported factors in this decision include distrust of banks, high fees, or large minimum balances. Although the size of the unbanked population has been falling over time, it tends to go up and down with the state of the economy and level of employment, having recently peaked at 8.2 percent of U.S. households in 2011 and risen again as the result of the pandemic, underscoring that for poorer households, checking accounts are often a good they choose to forego when income falls.

    Those without bank accounts still need financial services, including money transfer and credit. According to research by Mehrsa Baradaran on low-earners in How the Other Half Banks, expenditure on financial services by unbanked households could amount to as much as 10 percent of their income. Often, this spending is due to high interest rates (on such services as payday loans), wire fees (especially for those providing or receiving remittances), or overdraft/transaction fees on transaction accounts.

    Low-cost, low-minimum bank accounts were once widely available in the United States. In the 1960s and 1970s, an era of regulated deposit pricing, banks competed for new depositors through aggressive advertising and incentives (the proverbial toaster) and offered low-fee checking accounts with low or no minimum balance requirements. Customers with larger balances cross-subsidized those with smaller balances, since the cost of servicing smaller accounts was often greater than the revenues they generated. The repricing of this era was concurrent with the Savings and Loan Crisis and the associated declines in financial inclusion and access to low-cost financial services products have continued to this day.

    This post looks at some historical factors that accompanied changes in the supply of checking accounts to low- and moderate-income households in the United States. Part of this change in supply was structural, as institutions that had been founded to serve low- and middle-income communities either changed strategy or were acquired. Other changes happened at a product and customer level as banks reduced the cross-subsidies from higher-balance customers to lower-balance ones through minimum balance requirements, increased account fees, and overdraft charges.

    Comparative Market Structure

    All countries face challenges in achieving full financial inclusion, but the United States is relatively unusual among richer countries in the size of its unbanked and underbanked population. In neighboring Canada, for example, more than 99 percent of the population has access to a basic transaction account, including 98 percent of the poorest 40 percent of the population. Japan, Germany, Singapore, and the countries of Scandinavia show similar levels of access. The FDIC’s 2019 Survey of Household Use of Banking and Financial Services, in contrast, showed that about a quarter (23.3 percent) of U.S. households with annual incomes of less than $15,000 were unbanked, as were 10.4 percent of households earning between $15,000 and $30,000.

    The United States is also somewhat unusual among wealthier countries in the scale of its not-for-profit banking sector. The United States does not have a universal Giro- or Postbank, as in much of Europe or Japan, and although it does have a vibrant credit union sector (accounting for about 8 percent of all banking assets), the mutual banking sector is smaller than in many other OECD nations.

    This was not always the case. As recently as the 1970s, mutuals (thrifts, mutual savings and loans [S&Ls], and affinity-based mutuals) accounted for half of the residential lending market and commanded a significant share of the deposit market. A large number of these mutual banks were founded in the late 19th and early 20th centuries with the goal of ensuring financial inclusion for the working poor, at a time in which banking services were provided primarily to the well-to-do. Their missions were sometimes rooted in communitarian self-help and sometimes in paternalist philanthropy. Mutual savings and loans were present in most parts of the country and savings banks were once particularly prevalent in the cities and towns of the northeastern United States. Fraternal and friendly societies, including provident societies, also provided financial services as part of lodge, club, or church membership.

    FRED data show the rapid decline of mutual banks in the U.S. banking market, both in terms of their number and their assets. In the chart below, the rapid fall in the deposit share of mutuals between 1985 and 1995 is particularly apparent. Many of these organizations still exist, but are no longer mutual-based, having demutualized or been acquired by for-profit commercial firms and migrated upmarket along with their customer base.

     The Past and Future of the Free Checking Account

    While traditional mutuals have declined, there has been a revival since the 1980s in credit unions. Like the mutual savings banks and savings and loans, credit unions have a mutual structure, more akin to a not-for-profit, usually linked to some form of employer, professional affiliation, or local geography. While credit unions have grown their deposit
    base at nearly 7 percent per annum on average since the 1980s, nominal growth of other mutuals (savings banks, S&Ls) has been negligible.

    Over this same period (since 1989), commercial banks have grown in scale and scope, with total deposits growing from $2 trillion to over $17 trillion today. The acquisition wave that began in the 1980s has been associated with a commercial banking sector that is dominated by regional and national banking networks, which market themselves based on brand and convenience and do not generally compete on price in the market for retail deposits. The top four banking groups now account for more than 35 percent of U.S. commercial bank deposits.

    The Great Repricing

    Many factors came together in the 1970s and 1980s as banks began differentiating between higher- and lower-balance customers. Because deposit markets in this era were still very local and data on retail deposit pricing was just beginning to be widely available, we rely here on press and other primary sources’ descriptions from that era. In exploring why price differentiation grew in the 1980s and 1990s, we describe some of those factors, but we think of these as correlates, not proof of causality.

    Through their exposure to short-term interest rates, money market mutual funds offered savers higher rates and greater protection against inflation than demand deposit accounts could offer, as they were subject to Regulation Q restrictions on the payment of interest. To compete, banks launched a high-interest account with limited transactions allowed per month, the NOW Account (Negotiated Order of Withdrawal). These products were approved for rollout nationwide in 1980 by an act of Congress and a 5 percent interest rate cap was lifted in 1986.

    These products were widely popular with customers, but much less profitable on average than checking accounts had previously been. In the years following the introduction of the NOW account, banks searched for ways by which they could still offer interest on checking accounts without losing revenue. Banks instituted higher fees on lower balance customers and relatively high account minimums to ensure break-even for this new product. These balances (typically ranging on the order of $1,000 minimum balance at commercial banks, and around $300 at thrifts, such as savings banks and S&Ls) were publicly justified by bankers arguing that higher minimum balances reflected the increased break-even point on interest-paying deposits.

    There was extensive writing about these new accounts both within the press and in the burgeoning industry of saver-oriented consumer reporting. In 1983, the New York Times reported that account fees had more than doubled since the start of the decade and minimum balances for fee waivers, as high as $2,500 in some local markets, had been introduced. A few years later, Sheshunoff, a leading publisher of deposit product comparisons, reported that transaction fees on checking accounts nearly doubled yet again in many of the markets it covered between 1985 and 1988.

    In parallel, as changes in the deposit market intensified, mutual banks came under a long and painful period of financial stress on their lending portfolios. The causes and impacts of the waves of bank failures triggered by the Savings and Loan Crisis are covered in an extensive literature of their own. Many mutuals failed, converted, or were acquired in this period, but their deposits and branch infrastructure still made them attractive acquisition targets.

    Throughout the 1980s and early 1990s, through both voluntary and arranged mergers, struggling mutuals were among the first retail players to be consolidated in the two and a half decades of retail banking consolidation that followed. The loss of the mutuals reduced the options available to low-balance customers, particularly in the regional markets of the northeast where they had historically been strongest. Mutuals tended to have lower minimum balance requirements and lower fees. Studies from the period also show that commercial banks with large branch networks also tended to pay lower rates on deposits than either community banks or mutuals did.

    Due in no small part to increased computing power and growing sophistication in cost-accounting, customer-level profit segmentation became a lens through which banks have looked at retail customers, not only in banking but across a wide range of industries since the late 1980s. Banks needed to know what products to target at which customers and where the break-even points would be on each product, leading to changes in the way retail banks were managed at the customer level. A bibliography of some of this literature can be found here.

    With profitability segmentation, bank clients could be divided into “A,” “B,” and “C” tiers (“A” being the most potentially lucrative, but the terms will vary by firm) based on current balances and potential future profit. Higher balance “A” customers tend to cover more than their allocated share of bank expenses and make a large contribution to bank profits; customers in the “B” and “C” tiers tend to make a marginal or negative contribution. Consequently, lower tier clients saw an increase in account service and overdraft fees, so that they would be more profitable on a stand-alone basis. In more recent years, higher overdraft charges have continued this trend of imposing fees to make lower-balance customers more profitable.

    There may be signs of change in the market. Fintech firms are increasingly offering low-cost checking account options in a marketplace less tied to costly brick-and-mortar infrastructure. As of this posting, some major banks have also begun announcing an end to some or all overdraft fees on retail accounts (although other fees will likely stay in place). This may or may not be a longer-term trend, but it would go some way toward addressing one of the most clear-cut cases of product pricing impacting low-balance customers.

    The following post in this series will dive more deeply into the dynamics of account overdraft fees and their implications for inequality.

    Summing Up

    The great repricing of bank products that began four decades ago has been associated with profound changes in financial inclusion. Compared to that earlier era, there are fewer institutions offering low-minimum, low-fee accounts and retail deposit and transaction products are more differentiated based on balances, with the associated fees hitting lower-balance customers hardest. As a result, a substantial number of low- and middle-income consumers choose to be unbanked to avoid fees, a figure that rises when the economy is not performing well. Loss of access to a transaction account can have knock-on effects in terms of inequality, particularly through the mechanism of credit access, banking relationships, and credit histories. Greater availability of low-cost checking accounts, by this logic, would translate into higher rates of inclusion in what is arguably the cornerstone product for inclusion in the economy.

    If the past is prelude, this leads us to think about alternative futures. Will traditional banks increasingly forego fees and allow greater cross-subsidization between customer segments? As many credit unions offer increasingly liberal terms for membership, will they help fill the gap for financial inclusion? Alternatively, will technology fill the void, enabling banks or fintechs to serve clients that are currently high-cost much more cheaply so that there are very few “C” customers left? Or perhaps, as was the case a century ago, it is time for mission-driven organizations to think again about mutual banking?

    Stein BerreStein Berre is a senior vice president in the Federal Reserve Bank of New York’s Supervision Group.

    Kristian BlickleKristian Blickle is an economist in the Bank’s Research and Statistics Group.

    Rajashri ChakrabartiRajashri Chakrabarti is a senior economist in the Bank’s Research and Statistics Group.

    How to cite this post:

    Stein Berre, Kristian Blickle, and Rajashri Chakrabarti, “Banking the Unbanked: The Past and Future of the Free Checking Account,” Federal Reserve Bank of New York Liberty Street Economics, June 30, 2021, https://libertystreeteconomics.newyorkfed.org/2021/06/banking-the-unbank....

    Additional Posts in this Series

    Hold the Check: Overdrafts, Fee Caps, and Financial Inclusion


    Credit, Income, and Inequality

    Related Reading

    Once Upon a Time in the Banking Sector: Historical Insights into Banking Competition


    The ‘Banking Desert’ Mirage


    Economic Inequality: A Research Series






    Disclaimer

    The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

    The International Spillover of U.S. Monetary Policy via Global Production Linkages

    Published by Anonymous (not verified) on Thu, 17/06/2021 - 12:43am in

    Julian di Giovanni

    The International Spillover of U.S. Monetary Policy via Global Production Linkages

    The recent era of globalization has witnessed growing cross-country trade integration as firms’ production chains have spread across the world, and with stock market returns becoming more correlated across countries. While research has predominantly focused on how financial integration impacts the propagation of shocks across international financial markets, trade also influences these cross-border spillovers. In particular, one important aspect, highlighted by the recent work of di Giovanni and Hale (2020), is how the global production network influences the transmission of U.S. monetary policy to world stock markets.

    World Production Linkages and Stock Market Correlations
    The production process of a good or a service may spread across several borders before creating a final good. This global production process (often referred to as the “global value chain”) can be measured by the strength of connections between industry sectors across countries. This is a key first step to analyze international spillovers, since customer-supplier linkages are not equal in size. For example, there might be one key producer of an electronic component that is sourced by many customer firms, which use the component to produce their own goods. Such an asymmetry in the network then implies that shocks to a given firm, sector, or country will have different consequences across economies (Acemoglu et al. [2012]).

    The figure below shows that the distribution of production linkages across and within countries, where the unit of observation is the country-sector level (for example, the Chinese textiles sector). The figure uses data from the World Input-Output Database (WIOD) to plot the counter cumulative distribution function (the CCDF) of the weighted cross-country connections (outdegree) of a given country-sector. (Technically, the CCDF captures the probability of observing a given value of a variable within a data set. That is, if all observations in a data set are either equal to or between zero and one, the CCDF for the value zero would equal one, while the CCDF of observing a value of two would be zero.) This measure quantifies the importance of a country-sector as a supplier to other sectors across the world. Crucially, this measure not only captures direct linkages, such as the degree to which Chinese textiles are used in production by Vietnam’s clothing sector, but indirect linkages such as the subsequent use of Vietnam’s clothing by the Spanish fashion sector in its production of a final garment.


    The International Spillover of U.S. Monetary Policy via Global Production Linkages

    The figure’s construction is designed to line up the dots of country‑sector groups according to how important their connections are to the rest of the world. Moving to the right, it is clear that only a small fraction of the country-sector observations has strong global production linkages (outdegree greater than 1), while the vast majority of country-sector dots have small production linkages (outdegree of 0.01 or below). For example, the largest outdegree value belongs to manufacturing of food products, beverages, and tobacco products in the United States, while at the other extreme, sectors such as Australia’s repair and installation of machinery and equipment have zero cross-sector input-output linkages.

    The next figure shows that country-sector pairs that have the strongest production linkages also have more correlated stock market returns. The x-axis plots a measure of how close two country-sector pairs are along the global production network, where the larger the number, the weaker the linkages. The y-axis plots the correlation of sector-specific stock market returns of the corresponding country-sector pairs. As can be seen, the larger the trade (production) connection, the greater the pairs’ stock returns correlation.


    The International Spillover of U.S. Monetary Policy via Global Production Linkages

    How Monetary Policy Shocks Are Transmitted across Countries via Production Linkages
    The evidence presented in the figures above suggests that economic or financial developments may propagate along world production linkages and impact global stock market returns. However, several unanswered questions remain, such as how do shocks propagate along the global production network, and how important is the network’s contribution to the overall impact of the shock on stock market returns?

    The recent paper by di Giovanni and Hale (2020) begins to answer such questions by focusing on the transmission of one important shock: unexpected changes in U.S. monetary policy. The authors present a conceptual framework that lays out necessary conditions for monetary policy to be transmitted across countries via the global production network. In their setting, changes in demand induced by changes in monetary policy propagate upstream from customers to suppliers. Using a newly constructed data set, the authors use their empirical framework to quantify the role of the global production network in transmitting U.S. monetary policy across international stock markets. Crucially, the empirical estimation also controls for financial variables that have been shown to explain cross-country asset returns (Miranda-Agrippino and Rey [2020]). Further, the framework allows for the decomposition of the estimated impact of a monetary policy shock on stock market returns into contributions from a “direct effect” and a “network effect,” with the latter effect capturing the importance of global production linkages in shock transmission.

    Using monthly stock return data at the country-sector level, the estimation finds that the propagation of a U.S. monetary policy shock through the global production network is statistically significant and accounts for most of the total impact. Specifically, average monthly stock returns increase by 0.12 percentage point in response to a one percentage point expansionary surprise in the U.S. monetary policy rate, with nearly 80 percent of this stock return increase due to the spillovers via global production linkages. U.S. monetary policy’s directly impacts the domestic sectors and then spills over from the United States to foreign markets most prominently as the impact on U.S. sectors’ demand propagates upstream to those sectors’ foreign suppliers. This finding is robust to controlling for other variables that may drive a common financial cycle across markets, such as the VIX, the 2-year Treasury rate, and the broad U.S. dollar index. It is also robust to different time periods, different definitions of stock returns and monetary policy shocks, and to controlling for monetary policy shocks in the United Kingdom and the euro area.

    Implications
    The sizeable role of production linkages in transmission of U.S. monetary policy has a number of important implications. First, if international trade in intermediate goods continues to grow and global supply chains become longer and more complex, the impact of U.S. monetary policy on other countries is likely to increase as well. To the extent that this transmission channel is independent of capital flows and related policies, the results present one of the mechanisms by which capital controls may not be effective in insulating economies from foreign monetary policy actions.


    Julian di Giovanni
    Julian di Giovanni is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

    How to cite this post:

    Julian di Giovanni, “The International Spillover of U.S. Monetary Policy via Global Production Linkages,” Federal Reserve Bank of New York Liberty Street Economics, January 6, 2021, https://libertystreeteconomics.newyorkfed.org/2021/01/the-international-....

    Disclaimer

    The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.

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