Restoring Lost Tools, Reframing “Consumer Choice”

Tuesday, October 15, 2019

By Corey Stone, Entrepreneur in Residence, Financial Health Network

I’ve tried to mount a case that the new fintech apps that seem to have the greatest potential to improve consumers’ financial health represent “retronovations,” innovations that actually restore old practices. Earmarking income, adding fixed installments to revolving credit lines, digitizing and automating the check register, and compartmentalizing emergency savings will help households on tight budgets build savings, pay down debt, and have larger cash cushions at the ends of the month. They are expanding the options available to consumers who aspire to better manage their day-to-day finances, but haven’t had the tools to do so — until recently.

None of these retronovations relies on rocket science. All of them could have been introduced a decade or more ago as standard features of checking accounts. But it took the current environment favorable to fintechs — eager and plentiful venture capital and a maturing infrastructure of program interfaces and consumer data aggregators — to bring them onto the scene as stand-alone apps. The new services are attracting growing numbers of loyal users, many of whom gladly pay monthly subscription fees to access them. But with the customer acquisition limitations such stand-alone apps companies face, and with the ongoing integration challenges that come with use of data aggregation, servicing costs are high and market penetration among the consumers who need the apps most is likely to be limited.

So why haven’t more banks and credit unions offered these tools? After all, banks already have the customers and control the systems and information that the new apps use.

The simplest answer has to do with incentives. Here we face some uncomfortable facts: free checking — the prevailing pricing model for basic bank transaction accounts in our country — doesn’t directly reward investments that enhance these accounts’ functionality, even when such investments have potential to improve many customers’ financial health. Instead, banks and credit unions rely on overdraft fees to cover the costs of basic banking services; the continued struggles of roughly a tenth of accountholders, those who chronically fall just short of meeting their regular obligations at the ends of the month — and the overdraft fees they pay — subsidize free banking for the rest of us. The situation represents a massive and regressive transfer of somewhere between $15 to $30 billion per year from the least financially healthy to the financially coping and healthy.

A more nuanced answer has to do with our industry mindset, one we have adopted largely to explain and justify the status quo.

While some bankers I know are profoundly uncomfortable with the current situation, many others — faced with the reality of their dependence on overdraft fees and the threat of tighter regulations that could limit them — have dug in by hardening their convictions that overdraft is a valuable service and that even the most frequent overdrafting behavior reflects consumer choice. I’ve argued elsewhere that these convictions don’t fit the facts. The most frequent overdrafters are over-indebted, lack savings cushions, and chronically see their funds get low near the ends of each pay period. They gamble on transaction timing, hoping deposits will clear before debits in the crunch of payments that pile up at the end of the pay period. Most of the time they can’t predict whether they will overdraw their accounts or not. At best this is hoping or guessing, rather than “revealed preference.” At worst, it is acting on bad information: the available balance information banks provide on smart phones and on which consumers rely doesn’t account for ACH debits or checks in transit. Indeed, most overdrafts on debit cards — themselves, the majority of overdrafts — occur when the consumer’s account has sufficient funds to cover the transaction at the time of the authorization.

But the “revealed preference” narrative about checking accounts and overdraft also reflects some (perhaps willful) amnesia. The electronic banking and payment ecosystem that prevails in our country — a tottering edifice that imposes needless complexity and uncertainty and is past due for an overhaul — has not always existed.

The gradual transition from analog banking and cash-based payments to electronic payments and digital banking helped erode personal money management practices that were common in America two generations ago. Paper envelopes for earmarking funds for recurring expenses won’t work in an environment where the bulk of payments are by checks, ACH or debit cards. The art of maintaining and balancing a checkbook has largely been forgotten. Bank credit cards encourage overspending and overborrowing that fixed installment term loans once reined in; and they substitute for rainy day funds in emergencies. As a result, the old analog tools and habits that were born in the Great Depression and that enabled many of our grandparents to enjoy the post-war decades’ expansion of home-ownership and broad prosperity — even on tight budgets — have largely gone the way of the home-cooked family meal: saved for special occasions.

Built in increments over the last four decades, the payment systems and business model for transaction accounts have quietly become cultural artifacts that channel the habits and behavior of households. They have constrained consumer choice as much as they have facilitated it.

How do we open up our industry’s mindset and encourage banks to restore choice to consumers who want to retake control over their own financial behavior? I have two modest proposals for banks and credit unions to adopt the retronovations as part of their account offerings:

1. Build them. Banks (and the core processors and UX providers who power the retail technology of smaller banks and credit unions) could begin to build and offer these retronovations as features of an enhanced checking account offering. The cost to a large bank or a core processor to do this will be modest: at most, a few millions of dollars, not tens of millions.

2. Charge for them. To change the incentives that drive their current reliance on overdraft, depository institutions will need to charge more of their customers for basic banking services. In an upcoming article my colleagues at Oliver Wyman and I will argue that a $10 month fee will do the trick, but I think even $15 would be reasonable. Regardless of the amount, breaking from the “tyranny of free” becomes plausible when new charges come with a dramatic improvement in value: basic tools to enable users to manage their daily spending, tracking, borrowing, and savings behavior.

Initially, institutions that act on these proposals will be taking a leap of faith. It isn’t clear how many of the consumers who currently gamble on clearing sequences and regularly risk overdrafting at the ends of the month will instead choose to use digital versions of the old tools to manage their daily finances and be willing to pay modest monthly fees for them. But making the option available will give consumers new ways to avoid overdrafts and industry a way to test the validity of overdraft apologists’ narratives.

And, of course, banks that move first will have opportunities to capture profitable market share for basic banking services, while laggards lose some of their most profitable accountholders. That’s how consumer choice is supposed to work.

Explore the Ends of the Month Series on the Financial Health Network website.

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