What do you think would happen to a restaurant if it had horrible customer service and served mediocre food? Or a hair dresser who butchered your new 'do and then proceeded to re-run your credit card for an additional $10 tip?
I think we can all agree that they'd go out of business. At the very least, one wouldn't expect them to flourish.
Yet that's exactly what's happening with banks.
No surprise: People don't like banks
According to a recent Gallup poll, only 26% of people have either "quite a lot" or a "great deal" of confidence in their banks. In fact, Congress is one of the few institutions that scores lower in this regard, said financial bureau chief Matt Koppenheffer, author of our exclusive free report about the market's nine best dividend stocks.
And the nation's biggest banks are the worst offenders. In a J.D. Power & Associates survey of customer satisfaction from earlier this year, Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) ranked at or near the bottom of the industry in every geographical regional examined. And they were the absolute worst performers in this year's survey of bank reputations by industry publication American Banker.
At the same time, both of these banks, as well as the nation's largest lender by assets, JPMorgan Chase (NYSE:JPM), are racking up record quarterly profits. In the three months ended June 30, for instance, they earned a collective $12 billion.
What gives? If customers are so unhappy, why aren't they fleeing in droves?
The banks have you right where they want you
The answer it turns out has to do with switching costs -- that is, the amount of money and time it would cost a customer to switch from one bank to another.
Ever wonder why banks are such proponents of direct deposit and automatic bill pay? The reason is that it makes it harder for their customers to abandon them.
This point was driven home to me last week in a conversation with a New York-based banking consultant. According to him, the owners of between 40% and 50% of checking accounts at the nation's largest banks live paycheck to paycheck.
Imagine how delicate of a maneuver it would be for these people to switch banks without incurring an overdraft or insufficient-funds fee. If the direct deposit was transferred too early relative to the automatic bill pays, then the old account would be in jeopardy of a negative balance. If it was too late, then the new account would be.
Meanwhile, on the other end of the spectrum, larger account holders have little to no incentive to change banks, as they're treated comparatively well. I discussed this last weekend with respect to Bank of America, which has prioritized deepening its relationship with its 8 million "preferred" customers while at the same time cutting the costs associated with servicing its 40 million "retail" customers.
Don't worry, be happy
The net result is that, at least insofar as account retention is concerned, there's really no such thing as reputational risk for the nation's biggest banks.
Needless to say, this is great news for bank investors, as the negative press about the big banks' various transgressions should ultimately make little to no difference with respect to their success and valuations. But also needless to say, it isn't quite as good for the customers that unwittingly find themselves on the other end of it.