Eric Posner: How Can Banks Get Away With Charging Such High Fees?

How Can Banks Get Away With Charging Such High Fees?

Bernie Sanders wants to break up the largest banks. He blames them for the financial crisis and accuses them of overcharging customers. It’s not really clear that breaking up banks would reduce the risk of another financial crisis. Small banks fail, too, and can bring down other banks with them. But the accusation that banks gouge customers is a more interesting and complicated one. If Sanders is right about it, however, breaking up the banks will not solve the problem. The real villains are not the banks but their owners—the respected mutual funds and institutional investors who are not (yet) in his sights.

For quite some time, depositors have complained about banking fees. Banks sometimes charge you a fee to open and maintain a checking account; they often charge people fees for using ATMs managed by other banks. A great deal of controversy has surrounded “overdraft fees,” charged when customers write a check for an amount larger than the balance in their checking account. Critics argue that banks make money on overdraft fees because customers underestimate the risk of bouncing a check, which can occur just because of the timing that banks use to record credits and debits; banks in this way make money on mental lapses that everyone is prey to.

The controversy over fees has always puzzled economists. It’s strange that people complain about fees but not about the bank’s failure to pay more than 0 percent interest on checking accounts. The fees also reflect banks’ costs. Someone who never bounces a check or uses ATMs owned by other banks saves his bank some money—and so he is rewarded by being spared the fees that others must pay.

Moreover, Econ 101 tells us that when a market is competitive, the sellers will set prices at just enough to cover their costs. Although there are some huge banks like JP Morgan and Citi, the market in banking is, in fact, quite competitive. In most places—and certainly in densely populated cities—you can choose among dozens of banks; you can also use online banks. The competition among banks should drive down prices and ensure that depositors are compensated fairly. It should also ensure that banks efficiently choose whether to pay depositors in the form of interest or low fees.

However, a new paper by a group of economists casts doubt on this happy story.

Read more at Slate