Say Goodbye to These Tightwads

We all know that businesses have to make a profit. But when companies sacrifice strong long-term prospects for the sake of short-term retribution against increased regulatory scrutiny, it's a sign that their leaders aren't focused on what's really important to shareholders.

That's what we've seen from banks lately. Increasingly focused on maximizing short-run fee income, banks are losing sight of the big-picture competitive trends that could pose a much bigger threat to their long-term profitability.

Disappearing debit rewards
Last week, Wells Fargo (NYSE: WFC  ) became the latest bank to say that it would stop offering rewards programs for its new debit-card customers. The move has already taken effect for its Wachovia customers and will hit new Wells Fargo branch customers on April 15. For now, existing debit-card holders will have their rewards grandfathered in.

With the move, Wells Fargo joins JPMorgan Chase (NYSE: JPM  ) and SunTrust (NYSE: STI  ) , which have already made changes to their debit rewards programs. Chase stopped offering rewards for new customers in February and said that its rewards will go away entirely on July 19, while SunTrust will stop awarding points on April 15 and will eventually phase out remaining point balances at the end of the year. Citigroup (NYSE: C  ) reportedly is considering changes to its programs, although none have occurred yet.

Penny-wise
In what has become a familiar chorus, these latest moves appear to be in response to new regulations that limit banks' ability to earn profits. In particular, Wells Fargo directly cited pending restrictions on the amount that banks can collect from merchants for debit-card transactions as the primary cause for cutting rewards.

But banks that try to trim debit-card rewards are ultimately shooting themselves in the foot. For a number of reasons, it's smarter for banks to eat losses on debit cards rather than giving customers incentives to use other forms of payment.

For one thing, not every bank has discontinued its debit-card rewards program. At least for now, banks including Citi, PNC Financial (NYSE: PNC  ) , and Toronto-Dominion's (NYSE: TD  ) TD Bank unit still offer rewards for their debit-card offerings. If they buck the trend and keep those programs active, they could attract customers fleeing the other big banks.

Not giving customers credit
But more importantly, the move away from credit cards toward debit cards has a number of profitable implications for banks. Most analysts focus on credit card customers who carry a balance as the most profitable customers for card-issuing banks. From their standpoint, those who pay off their balances every month are "freeloaders" who don't pay their fair share of interest and other fees and therefore take advantage of balance-carrying cardholders. Moreover, although some banks have tried to limit credit card rewards as well, many reward programs are alive and well -- and again, so-called freeloaders are in the best position to take advantage of them.

But in pushing these customers toward debit cards, banks have restored a measure of profitability to that customer segment. Rather than allowing balance-paying card customers to float their balances for an entire month or more, debit-card users have their balances reduced almost immediately after they make transactions, eliminating their float and letting that money flow back to banks more quickly. And with a huge difference between the rates that banks pay on deposit balances versus what they're earning on loans right now, that means extra profit for banks.

In addition, debit cards encourage customers to keep higher balances in what tend to be lower-rate checking accounts. Unlike paying off a credit card balance once every month, a debit-card user always has to be prepared for a big purchase that could overdraw a checking account without enough funds.

Get smart, banks!
Perhaps most importantly, banks assume that they have a monopoly on point-of-sale transactions. But that may soon change. Smartphone-based payment systems are the wave of the future, with Google just announcing earlier this week it would work with MasterCard (NYSE: MA  ) and Citi on a near-field communication system for Android phones. Although Google's partnership involves a bank, the future may bring alternative systems in which banks play only a minor role, if any.

So when banks complain that they won't be able to charge as much for debit-card transactions as they have in the past, what they're really doing is making a shortsighted mistake. In reversing all the progress they've made in pushing customers toward debit-card transactions, they may end up losing a whole lot more in longer-term profits. For investors, it may be time to start saying goodbye to the banks.

Keep your eye on debit-card rewards-cutting banks. Add them to your watchlist today.

Fool contributor Dan Caplinger gives banks as little credit as possible. He doesn't own shares of the companies mentioned in this article. Google is a Motley Fool Inside Value and Motley Fool Rule Breakers recommendation. The Fool owns shares of Google, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy protects your money.


Read/Post Comments (5) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 29, 2011, at 12:48 PM, TCB47 wrote:

    After all, on debit cards, you're using your own money, not a loan from the bank. So naturally, the banks want to penalize you. The idea that somehow customers who use credit cards wisely are called freeloaders and in some cases deadbeats defies logic. Is it any wonder Henry Ford hated banks? Thankfully, American Express encourages proper usage and their rewards program is so much better than any offered by any of my banks. Most have already jacked the interest rates up into the stratosphere, even for their good customers. What sane person would trust a bank these days.

  • Report this Comment On March 29, 2011, at 4:27 PM, ronbeasley wrote:

    I'll bet Wells' and JP Morgan's CEO's are breathing a sigh of relief. Doubtless, they have been waiting for a Motley Fool blogger to tell them how to run their banks. And now, Dan Caplinger is obliging them. Maybe he'll be invited to join their boards? Don't you just love these self-appointed know-it-alls?

  • Report this Comment On March 29, 2011, at 5:59 PM, TCB47 wrote:

    Rombeasley:

    Might be true but I know I will not use the banks for anything but a temporary depository. Chase refused to credit a cashiers check for immediate use to my account and instead held it like a regular check for 10 days clearance. I will never again use Chase for a large deposit.

  • Report this Comment On March 30, 2011, at 8:58 AM, CWKnob2 wrote:

    Hmm ... I am reading these posts and scratching my head. TCB47 lost his free gifts so the bank will do what you expect it to do. Process your transaction. The free gift part was the business-building part. Now debit cards are ubiquitous. Every little Mom & Pop shop has a card-swiper.

    If the banks really fall into the NFC type payments, expect a new wave of free gifts presented that way to build the NFC business.

    You seem to have a rightful complaint about 10 days. But that seems to be based on state banking law and what your state will allow. In Connecticut, it is 3 business days for in state checks and 5 business days for out of state checks.

    Money market drafts used to be drawn up by brokers, and the cash taken from your account that day. I remember when Merrill Lynch used to draw money market drafts to East Coast clients on a California bank and the West Coast clients on a New York Bank. An extra day for mailing, and and extra few days for the checks to clear ... it was big business until they gave money market fund holders their own checks.

    There is just one rule. Everything will change.

  • Report this Comment On March 30, 2011, at 1:21 PM, KKnese wrote:

    Why keep your money in a bank when you can belong to a credit union? CU's are mutually owned, which means interest on accounts (called dividends) is not based on the minimum the market demands, but on how much profit the CU is making on loans and fees. In other words, the more you save, the more you get and the less you save, the less you get.

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