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ATM Surcharges and Bank Consolidation

posted by Adam Levitin

Last month Bank of America raised its ATM surcharge from $2 to $3. The surcharge is the fee charged to customers of other banks for using Bank of America’s automated teller machines (ATMs). Bank of America is the first bank in the United States to raise its ATM surcharge to the $3 level.

Why did Bank of America suddenly raise its ATM surcharge 50%? My theory is below the break.

BoA's surcharge increase clearly has no relationship to BoA's costs. My theory it is that it is a way for Bank of America to increase its depositary base (a low cost source of funds) and continue its leading role in consolidating the US banking industry.

Banks love deposits. Deposits are a really cheap source of capital. A deposit is an interest-free or low-interest loan to the bank, which the bank then reinvests at a much higher rate of return. Deposits fund banks lending operations, and as banks are finding themselves with more bad real estate loans on their books, they need to boast their deposit base to meet reserve requirements.

There are two ways a bank can grow its deposit base—organically and through acquisitions. Acquisition growth is limited, however, by the Riegle-Neal Act, 12 U.S.C. § 1842(d)(2)(A), which prohibits banks from entering into acquisitions that would result in their holding more than 10% of the deposits in the United States. In 2004, Bank of America came perilously close to the 10% limit, when it acquired Fleet Bank. Bank of America’s on-going attempt to acquire LaSalle Talman Bank in Chicago once again raise Riegle-Neal Act issues.

ATM surcharges encourage organic deposit growth at large banks. They do this by encouraging growth in ATM deployment, which in turn makes bigger banks more convenient because they are everywhere. Since state legislatures began banning ATM network no-surcharge rules in 1996, ATM deployment has soared. Banks are now willing to place ATMs in Podunk places because they can rapidly recoup the costs through surcharges since the out-of-the-way ATM is a local monopoly. And the increased scope of individual banks’ ATM networks adds to the convenience of banking at those banks. Not surprisingly, big banks have more ATMs on average than small banks. This means, that if you bank at Smallsville Bank, you know that you’re going to be paying ATM fees if you need to get cash outside of Smallsville. If you bank at Bank of America, though, you know you can find a (fee-free) Bank of America ATM relatively nearby in most locations. ATM surcharges increase large banks’ ATM deployment, which increases the convenience of these banks.

A bank’s ATM surcharges also raise the cost of doing business at other banks. Again, this accrues to the advantage of bigger banks (and does so regardless of whether the non-surcharging bank covers the ATM fee itself). So, it makes sense to be a front-runner on ATM fees like Bank of America. Bank of America won’t lose any customers because of its ATM fees because the fees only apply to non-customers. Instead, Bank of America makes itself more relatively more attractive to other banking options through its ATM fees. Indeed, ATM surcharges were a major (if not totally rational) factor in my own decision of where to bank. When I relocated to the DC area, I chose to give my business to a large national bank instead of the local bank, which has superior service, because I wanted to be able to access my funds easily and without a surcharge across the US. While I probably would not have incurred much in the way of fees had I gone with the local bank, I resented the idea that I would be paying a penalty.

ATM surcharges also help Bank of America grow without bumping into the Riegel-Neal limit on growth by acquisition. BoA’s ATM surcharge increase can be explained as an attempt to spur organic deposit growth--at the expense of smaller banks. If Bank of America can’t buy up the smaller banks, then it can accomplish much the same by siphoning away their business.

America’s banking system is unique in the developed world for its sheer number of banking institutions. The United States has around 8,600 federally insured depositary institutions. By comparison Germany has around 2,400 banks, France has about 850, the United Kingdom under 300, and Canada has 150. The large number of banks in the US are a result of historical banking regulations, which reflected a deep-seeded suspicion of accumulated capital, and prevented interstate branch banking until 1994. The banking industry is rapidly consolidating, however. There are now have only two-third as many federally insured depositary institutions as in 1993, when interstate branch banking restrictions were still in effect.

All of this raises the question of whether a concentrated banking industry is a good thing (and for whom). The question resembles the debates about the impact of Wal-Mart on the economy. There are cross-cutting effects of banking concentration. Bigger banks might be more fiscally sound, which is good for consumers who have deposits beyond the FDIC caps. Big banks are certainly capable of doing more things than smaller banks, including setting up independent credit card networks, which could benefit consumers. On the other hand, consumer service tends to suffer at bigger banks, and bigger banks also have more political weight on regulatory issues, usually against consumer interests. And to bring it all home to “credit” and “bankruptcy,” when banks grow their deposit base, it has the same effect as lower interest rates—lower cost of funds, which means that banks are more willing to make riskier loans, some of which will enable consumers to live out their dreams and some of which will end up in painful defaults.

Is BoA’s increased ATM fee going to fuel another glut of subprime lending? Of course not. But is it going to drive consumers from small banks to BoA? Certainly. And when an 800 lb. gorilla gets bigger, we should take notice.

I know this was a long post—thanks for staying with me all the way to the end. I’ll try to be more succinct in future posts.

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Comments

Smaller banks can and do fight back, though. My own bank offers up to $6/month refunds on "foreign" bank ATM fees. (http://www.firstib.com/personalaccts/checking.html) BofA's move makes it somewhat more likely that I'll hit the limit, but I usually don't get cash more than twice a month, so I'm not likely to have a problem even with the new fees.

Wouldn't have anything to do with all the bank runs would it?

Elizabeth rightly notes that some banks cover "foreign" bank ATM fees. But this is just a heads, I win, tails, you lose situation for the surcharging bank. Either depositors like Elizabeth move their accounts to the surcharging bank or the surcharging bank gets a fee. And how much better is it when that fee is paid by a competitor?

Let me point out that I am not the first to note how ATM surcharges impose costs on competing banks and that this particularly hurts small banks in competition for deposits. In particular, David Balto has done important work on ATM surcharges, and I commend it to interested readers. See, e.g., David A. Balto, ATM Surcharges: Panacea or Pandora's Box? 12 Rev. of Banking & Fin. Service 169 (1996).

Adam, I think what you're describing is tying, and at least in this instance it's fairly clearly an anticompetitive tactic. ATM surcharges exist largely because banks have an incentive to tie together two related but distinct markets -- deposits and ATM transactions. Just as Microsoft tied together its operating system, browser, and other software, leveraging its OS monopoly into those other markets, Bank of America charges nondepositor customers a much higher price for use of its ATMs, seeking to induce them to purchase its deposit services. (Another example is Comcast -- one effectively must purchase Comcast cable TV service in order to get Comcast Internet service. It's possible to get Comcast Internet a la carte, but it costs more than purchasing Internet and cable TV together.)

David, there is definitely a tying of ATM and deposit services. But tying is not per se illegal unless it is done by a party with market power, which is usually defined as the power to control prices or exclude competition in the relevant market. Bank of America doesn't dominate the ATM market the way Microsoft dominates the OS market or Comcast dominates local cable markets. It's hard to argue that Bank of America (or any other bank) has market power in terms of ATMs or deposits, and tying isn't necessarily economically harmful to consumers.

Whether BoA dominates the ATM market depends on how broadly that market is defined. It's not a single national market; clearly it must have at least some geographic boundaries. An ATM in midtown Manhattan obviously is not a viable substitute for one in Washington, D.C., and it's unlikely that one in Adams-Morgan would serve as a viable substitute for one on Capitol Hill, except possibly for a person who lives in one of those neighborhoods and works in the other. I suggest that the relevant market may be much narrower than that, given the relatively low cost of the goods involved and the fact that ATMs are primarily a convenience good in the first place. If the cost or inconvenience of walking two blocks to get to a different bank's ATM, for example, is sufficiently high that most people won't consider doing so, then even that relatively short distance is enough to separate these two nearby ATMs into separate markets. Viewed in this way, Bank of America probably does dominate the ATM market in many of its ATM locations -- for example, if an airport or shopping mall or supermarket rents space to only one ATM operator, that operator may effectively have a local monopoly. In a supermarket, of course, the ability to get cash back in a point-of-sale debit card transaction serves as a sufficient substitute for the ATM. Perhaps that's why BoA is initially rolling out its new $3 surcharge only in its own branches and in supermarket locations, but apparently not (yet) in other locations where its dominance of the ATM market is more pronounced.

Adam, welcome to the blog!

I generally agree with your posting on ATM fees, and as someone who works within the banking and ATM industry, I have some perspective on using ATM deployment as a tool to generate deposit growth. I would add the following comments.

First, the argument that prolific deployment of ATMs gives an advantage to a large bank may be true, but that argument is, in my opinion, far more true when applied to deployment of brick and mortar branches. The banks with the most branches in a given market have a definite competitive advantage. Of course, the same may hold true for supermarket chains, gas stations, or almost any other consumer retail business. Just like ATM fees, most banks will cash checks for their own customers, but will charge a fee for cashing checks for non-customers.

The same principles may also apply to ATM deployment on a lesser scale. However, there is one major difference - an ATM costs a whole lot less to deploy than a bank branch. Therefore, an entrepreneurial smaller bank can begin to level the playing field with their larger competitors by deploying lots of ATMs rather than building lots of branches. In the case of the bank I work for, we were ranked number five of about 9 banks in our market in terms of deposits and branches, with 11 ATMs in 1996. We were concerned when our larger competitors began charging our customers for using their ATMs, for exactly the reasons you described. So, we fought back by aggressively deploying off-premise, non-branch ATMs throughout our state to turn the tables on the big-bank holding companies. We now have over 300 ATMs, by far the largest bank ATM network in our state, with 50% more than the largest bank and twice as many as the second-largest bank. Bank of Amercia probably has less than 5 ATMs in our market. We now have only about 25 branch ATMs, but nearly 300 non-branch ATMs. We have used ATMs to make a smaller bank more competitive with the larger banks.

Another approach is for a community bank to partner with a non-bank ATM deployer to make their ATMs free to the bank's cardholders. This is typically done in exchange for the bank providing the cash inside the ATMs for free or at a discount. With this approach, a small bank can co-brand numerous ATMs in their market without having to invest in the equipment or servicing costs, providing a surcharge-free ATM delivery channel without the capital investment.

A third variation is to join a national network of surcharge-free ATMs. There are several networks that let a small bank or credit union direct their cardholders to thousands of free ATMs across the country, without paying for the cost of deploying those ATMs.

So, while a prolific ATM network can indeed be an advantage, they are equally available as a delivery channel to small banks as well as larger banks. Combined with great customer service, great Associates, and competitive pricing, ATMs can actually help the Davids beat the Goliaths of the banking industry.

David is right to point out the geographic element of market definition. I agree that it isn't a national market--BoA didn't raise its fee nationwide--but as David's comment shows, though, determing the relevant geographic market for ATMs is tricky. If convenience is the primary factor it's easy to end up seeing every ATM as a market unto itself. I should also point out to readers that there is antitrust litigation pending over ATM fees. In re ATM Fee Antitrust Litigation, U.S. District Ct. Case No. CV 04-2676 CRB (N.D. Cal.).

I am very appreciative of Tom's insights. It's really good for to hear from people in the industry--the hands-on knowledge adds a lot to the discussion. It seems like the picture isn't so bleak for smaller banks and credit unions.

I would add another thought regarding ATMs, though. Consumers can get cash without a fee as part of a "cash back" option on a PIN debit transaction. As ATM fees rise, it might push consumers to greater use of PIN debit, most of which is run on independent (non-MC/Visa) networks.

This was a great read!!!
A few comments to add from a unique perspective. I am involved with, what "we" consider the true "off premise ATM market". That would be any and all ATM's not "branded, or Co-Branded" for the matter, by a Consumer Bank. I thought it would be interesting to put this out there and here some of your thoughts. The "off-premise" market is made up of ISO’s and of just the two largest that I know of makes up for more than 40,000 ATM's Nationwide. I am an active participant in the deployment of these ATM's and have had a difficult time bringing more of the local/smaller banks into this exact type of discussion. The comments by Tom were very insightful and in my opinion, the answer for any smaller institution, trying to fight back and mitigate any customer/revenue loss to the larger banks. (Even prior to the BOA move)

Why wouldn't more of the smaller banks look for "alternative" ways of expanding their market share in a given market (no matter how you define, that interested market) by expanding their ATM presence/convenience? More specifically however, when will the day come, that these banks begin to take notice of the extremely large base of "off premise ATM's". These are available for a fraction of the price of operating their own terminals, and are currently run and operated by reputable and yes "compliant" Companies. Why not take terminals already in place and simply "pay" for a co-branding of that terminal and consequently the same "free" transaction benefit? This business has always appeared (too me) as a sprint/race for real estate. BOA's move simply boosts that theory for us. Only difference is where the smart players are running, too acquire that real estate.

Off premise has been defined in our circles as "non consumer-bank affiliated", I am waiting for the realization of off premise being defined as any ATM terminal "manufactured" other than those associated with the "big two". Costs associated with running any network of terminals has to first look at the manufacturer of those terminals, and in close second, service providers available to work on those terminals. I have heard rumors, (and while this may still be considered inexpensive) for a bank to pay on average $500+ per month per terminal, to run those terminals? (CRAZY!!!!!!!!!!!!!!!) Deposits, I would think have to be the number one goal but, shouldn't old fashioned due diligence, and cutting costly expenditures be next in line?

The day will come that we all run out of "GOOD" locations, when does the idea of "Bank Consolidation" stop becoming the only alternative to creative "out of the box" moves such as BOA's?
There are ways of continuing the smaller banks presence, and of KEEPING the smaller, better value, better service oriented banks, it is simply through plain old, good partnering & smart ALLIANCE's.

I read down through the entire blog this morning. I have an EFT (ATM/Debit processing) consulting firm and work with financial institutions exclusively. Prior to that I sold processing services for one of the "Tier 1" EFT processors and before that, was Director of Operations of a privately owned armored car company that focused on ATM services (cash replenishment & maintenance). All of my experience in this subject matter doesn't make my opinions necessarily any more right then anyone else's posted here. Having said that, let me take a "whack at this."

The one thing that seems to be missing here is the understanding of the expense of maintaining an ATM "network" not to mention issuing cards. Most Banks accept this as the cost of doing business. I have to admit that I never really thought much about the idea of large banks using their ATM's to TRY create a cheap source of capital by bringing in new deposits. I say try because like with everything else, there are obviously no guarantees when a FI deploys new ATM's.

Let's delve into this idea of expense. Higher function machine that have deposit capabilities or can access payoff figures for loans can easily cost $35,000+.

Then you have the maintenance (first & second line) as well as the communications (routers, modems, circuits, etc...) costs.

We also can't forget the cost of funds issue. While it is true that FI's can count money in ATM's vaults toward their mandated cash reserve requirements, many FI's don't take advantage of that "loophole."

There is also the issue of the regulatory bodies (ATM & Debit Networks included) shoving one requirement after another down the throats of the institutions they regulate i.e. ADA (I mean come ON! A drive up ATM that has to have a braille overlay on the keypad). Some mandates like triple DES and account # truncation are good but others are silly and ALL of them cost the terminal owner (not just FI's) money!

All I am saying is that when your wallet is empty and you walk up to an ATM, the green stuff that comes out of it, while it may be ultimately coming out of your account, what you are holding in YOUR hand right THEN is the terminal owners money and they deserve a fee for providing a service.

We generally don't seem to squak too loudly when Blockbuster charges us a "late" fee when we return that AWESOME DVD a day late because we wanted to watch it a second time. We don't piss and moan about the toll we pay to cross a bridge that cuts 20 min off of our travel time home in the evening. How about that ATM in the big city "titty bar" that dispenses ONES??? No dude is crying foul there at the $7.50 fee but we are going to make a big deal out of $3 at a BofA (and now Wachovia) terminal. Doesn't make sense.

I have NEVER liked the word "surcharge." If we called it what it really is, a "convenience fee," perhaps it would be a bit more palatable. Afterall, in this GREAT country of ours, that is what we do: Pay for convenience!

On the issue of ISO terminal owners, while I agree they provide a service, and as stated above are clearly entitled to reasonable fees charged, there is a stigma surrounding that business model.

Current times have shown many of the more reputable companies have absorbed the "little guys," so it's not the issue it once was. However, in 1996 when "surcharging" became the rave, every seedy little man on the earth seemed to crawl out from under their rock with the idea of earning an easy quick buck! IT WAS BAD (and sometimes still is)! ATM's sat out of service for days. People showed up with a pocket full of 20's that kept the machine running for all of 7 hours. They didn't pay the location owner the "royalties" they promised. It was a mess and unfortunately, FI's are simply always going to remember that reputation and will forever be wary!

Someone earlier mentioned surcharge free "networks." There are a few fairly large ones. The biggest (Allpoint) in my opinion is not a good financial move for the community based FI. They are charged ($.40 - $.50) per month for every card they have out of "the system" whether that card gets used or not. When an FI only has 54% of their cardbase active in a given month and 75% of the transactions being done on their ATM's are by THEIR cardholders, it simply doesn't make sense.

In closing (and Adam thought his post was long), there is nothing anti-competitive about the ATM industry in the least. If you don't want to pay a fee, bank with a FI that has an ATM that is regularly convenient. If it is one of the "BIG BOYS" then do so at your own peril when it comes to service. If not, then pay the "convenience fee" and stop whining!

Adam, I completely agree, and in fact have been saying the same thing since BoA's announcement first came out. Thank you for explaining the point more completely than I did though.

Here's another interesting minor supporting point: all institutions place relatively higher value on higher income customers, and those that travel more certainly fall among this segment. Frequent travelers value ATMs more, are more likely to have multiple financial accounts, and BoA is among the very few truly nationwide banks. Therefore, BoA can give frequent travelers a financial incentive to consolidate financial activity at their institution.

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