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On the one hand, banks are figuring out ways to recover some money that they are bound to lose due to the imminent cut in interchange fees, as dictated in the Wall Street reform legislation last year.
On the other hand, credit unions are gaining more popularity among consumers as alternatives to banks for their higher rates and lower fees. This recent development in the banking sector was reported in The Street on Tuesday.
The trend is expected to gradually transmit the profit origin of banks to the credit unions. The obvious question that now arises is –– will these credit unionsbe able to replace banks?
Like the Federal Deposit Insurance Corporation (FDIC) guarantees bank deposits, The National Credit Union Administration (NCUA) supervises the nation's credit unions and guarantees their funds. So safety and soundness is not likely to be a concern for consumers who choose credit unions over banks.
Problem with Banks
According to a provision in the 2010 Dodd-Frank act, the Federal Reserve needs to cap the interchange fees for U.S. banks including JPMorgan Chase & Co. ( JPM - Analyst Report ) , Bank of America ( BAC - Analyst Report ) and Wells Fargo ( WFC - Analyst Report ) . The rule was supposed to be enacted effective July, but faced lobbying resistance. The Federal Reserve board will again meet on June 29, this time to issue its final rule.
Pursuant the adoption of the cap, it would be significantly difficult for big banks to earn revenues from debit card interchange fees. So the banks are hatching plans to enforce a cap on the amount of transaction that consumers can through their debit cards.
This way, the banks would be able to recover some profits that they would have to sacrifice to the Federal Reserve. Needless to say, consumers who genuinely depend on a debit cards would end up being victims of the banking device.
What are Interchange Fees?
For every swipe of a debit card, the related bank charges a fee to the retailer. The bank then shares the amount with its card partners such as Visa Inc. ( V - Analyst Report ) and Mastercard Incorporated ( MA - Analyst Report ) . The charged amount is called interchange fees.
Magnitude of the Cap
In December, the Federal Reserve proposed to cap interchange fees for big banks at 12 cents per transaction. This represents a decrease of about 75% from the previous average. According to estimations by the banking industry, this would drain about $12 billion in revenues annually from the sector.
Role of Credit Unions
Coming to credit unions, these are owned by their members who elect volunteer directors for governance. These credit unions operate as non-profit organizations with a lower expense base than banks. As a result, if they generate more than their required capital, the surplus is distributed among members.
There are two types of credit unions, namely retail and corporate. Retail credit unions lend money and take deposits from individuals. However, corporate credit unions do not deal directly with consumers. These institutions provide financing, check clearing and other services to retail credit unions.
How Attractive are Credit Unions?
According to RateWatch’s industry data for last week, the average rate for a 12-month certificate of deposit with a $10,000 balance for the nation's credit unions was 0.75%, significantly higher than the average rate of 0.45% for banks.
Also, for interest-paying checking accounts with no minimum balance requirement, the banks paid at an average rate of 0.08%, while the credit unions paid twice the average rate.
Additionally, credit unions are at par with banks with respect to deposit insurance. When a bank fails, the FDIC reimburses customer deposits of up to $250,000 per account.The NCUA has also raised the basic share insurance limit of credit unions to $250,000. So credit unions are in a competitive position to attract deposits from consumers.
Where Do Credit Unions Stand?
Retail credit unions seem to be in good shape. But it’s also true that corporate credit unions are facing major trouble because of the high-risk mortgage-backed securities they bought from some major U.S. banks.
But the NCUA is not sitting idle. The Administration is pursuing banks that deceived credit unions for their own interests. On Monday, the NCUA sued JPMorgan and Royal Bank of Scotland PLC ( RBS ) , alleging these of deceiving five large credit unions by selling them more than $3 billion high-risk mortgage-backed securities that were expected to underperform.
At the time of selling investment vehicles backed by mortgages to these corporate credit unions, JPMorgan and Royal Bank of Scotland made several misrepresentations in the offer documents to make them believe that these investments are attractive and less risky. In reality, however, these securities were laden with heavy risks.
Subsequently, shortly after buying these securities many of borrowers faced a default and the five credit unions failed. The NCUA seized two of the five credit unions in 2009 and the remaining three in 2010.
Of the total 7,000 U.S. credit unions, a significant number of institutions are victims of the mortgage crisis. Since 2009, more than 40 credit unions have failed and several others are struggling to survive.
However, the regulators are proactively trying to recover losses of credit unions through lawsuits against banks that were involved in malpractices related to selling mortgage-backed securities. The proceeds from these lawsuits would increase NCUA's insurance and emergency support funds to a good extent.
So Are Credit Unions Better Alternatives?
There is no reason to think that credit unions are not safe for deposits considering their regulator’s guarantee on funds. Moreover, these institutions are now becoming more feasible options as banks are trying to recover their lost fee revenues from customers.
The big banks are already ridden with lawsuits. Now if customers shift their loyalties to credit unions, it will be a big punishment for the banking behemoths. Not only will the penalties come as big prices, lower deposits would make it difficult for these banks to keep their financials stable.
Most importantly, consumers will be able to avoid the cost of keeping deposits with banks. Whether credit unions will actually replace big banks is still to be seen. But, without an inkling of doubt, credit unions are better alternatives right now.
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