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.
