As signs of economic recovery begin to show up in various business sectors around the country, the banking industry remains stalled in its efforts to overcome the effects of the economic meltdown that started on Wall Street in September 2008. While the mammoth Wall Street Banks were boosted by the largest government bailout in history, many institutions that line Main Streets across America weren’t in a position to take advantage of the Troubled Asset Relief Program (TARP) program.
Instead, these institutions have been on their own to balance the collapse of the real estate market, lowered interest rates and additional assessments exacted by the Federal Deposit Insurance Corporation (FDIC) to help maintain the reserves to its deposit insurance fund. This fund insures bank deposits up to $250,000 per depositor in all U.S. banks. And while most banks are working through their challenges, according to the Federal Reserve more than 135 banks across the country have been forced to close since the third quarter 2008.
How do banks make money, anyway?
Under normal economic conditions, the formula for a bank to make a profit is pretty simple. Customers deposit money into the bank, which in turn lends that money to other customers at a specified interest rate. As long as the bank earns more in interest than it pays to customers on interest-bearing accounts (like money market and savings accounts) and for other expenses, it should make money. In the past, banks were able to do this by adjusting up or down the rates they charged on loans.
However, soon after the massive government bailout last year, the Federal Reserve lowered interest rates to stimulate the economy by making it more affordable for small businesses and individuals to borrow money. But this made it more difficult for banks to earn enough interest income to cover the losses of payment on loans in default (when customers could no longer afford to make their payments). With increasing loan default rates, banks were required to set aside larger amounts of funds to meet expenses and cover the costs of problem loans.
To offset lower interest rates and these additional expenses, banks have become less flexible in loan pricing and have lowered the rates they pay on interest-bearing accounts. They are also relying on non-interest income – which includes fees charged for services like checking accounts, ATM withdrawals, balance transfers, safe- deposit boxes, overdraft coverage and cashier’s checks – to help make up the difference.
The increase in fees has recently come under media scrutiny. Especially those being charged by some of the larger banks that were part of the government bailout. In an industry where the average profit margin is now 1% to 2%, compared to 10% to 25% for other businesses, it may be that the laws of the jungle, where only the strong will survive, will prevail in the banking world.