A lot of smart folks have had much to say about the CFPB suit against Capital One recently. At Klaros, we have had a few lively internal discussions, as well as an interesting conversation with Marketwatch’s Andrew Keshner. Rather than try to summarize everything that’s been said, I wanted to highlight a few things that we’ve been thinking about - and that banks should keep an eye on.
The practice of having different rates is not on the face of it wrong
As Konrad Alt pointed out, the savings and loan industry relied on a tried and true formula for decades that had a lot in common with the deposit practices that seem to have gotten Capital One in trouble:
post a high promotional rate on 1-6 month CDs, bring in lots of new accounts and deposits;
when the CDs mature, roll the balances to non-promotional deposit products at materially lower rates;
keep rolling the customers to lower rates with each successive maturity until you’ve got really low-cost funds.
Of COURSE S&Ls didn’t alert their portfolio customers to new promotional rates when their CDs matured; the whole point of this practice was to generate really low-cost deposits. Interested consumers could always find current promotional rates in the newspaper or on banners on the front of local branches, but the burden was on them to do so.
The strategy was remarkably effective. When those initial promotional rates expired, you rarely lost more than 5-10% of the deposits; the remaining balances (about the same as what you initially brought in after interest credited) rolled into lower-cost funding at every maturity because very few consumers monitor their rates closely all the time. While nothing stopped consumers from moving their money to the current promotional rate when their CDs matured, relatively few did so. Most only tuned in every few years, not at every maturity.
Far from raising regulatory eyebrows, banks that have followed such practices have been rewarded by the FDIC with lower deposit insurance premiums (relative to brokered deposits).
But the current climate has changed, particularly with respect to two variables
The CFPB's hyper-focus on consumer equality is the first new variable. The second is that the CFPB has historically paid closer attention to deposit products offered by online/digital banks than traditional branch networks. It’s surprising Cap One didn’t conform its deposit strategy to these variables.
Regulators have different mandates and agendas
Patrick Haggerty noted that this is a fascinating example of consumer protection regulation clashing with prudential regulation. If Cap One had pushed all of its customers to the highest-tier products, the OCC would probably have hammered the bank in liquidity exams for having an over-concentration in rate-sensitive funding (not to mention the adverse market pressure they would have experienced for having high funding costs). Solving across multiple regulatory mandates is complex, challenging and an argument for consolidating supervision to fewer or a single regulatory agency, although that proposal has been raised and tabled before.
Is it the marketing that’s at issue?
While the complaint strongly suggests the CFPB believes that Capital One (and, by implication, other banks) had an obligation to keep its customers apprised of its most favorable rates, it stops short of actually saying as much. And the complaint makes a little more sense read narrowly as a deceptive marketing claim: “Capital One promised consumers . . . that their savings would ‘earn much more’ in interest that ’what it would in an average savings or money market account.’”
Query whether a reasonable consumer should understand that promise as having an indefinite term, but - ok, they promised consumers above-average interest and didn’t deliver it, so it was arguably deceptive marketing. If this is the real issue, a jury trial could be disastrous for Capital One. A jury is much more likely than a judge to look beyond the law and envision a moral imperative.
While social media needs to be considered in risk management, it doesn’t always play the same role because of psychology.
Initially, I was surprised there wasn’t more of a social media backlash from Cap One’s depositors. To date, consumer response to the bank’s practices seems muted, at most. Why? Banks operate on the confidence of their depositors. We’ve seen how quickly liquidity sours when reputational issues arise. But behavioral economics tells us that consumers are more motivated when they believe they were charged a fee in error than when they missed an opportunity for interest income. Economically it’s the same, but human behavior skews towards loss avoidance.
Is banking different (and should it be)?
Patrick Haggerty noted that the case also raises liquidity risk management issues and, more fundamentally, core business model issues. How attractive would retail deposit funding be in a world in which banks had to promise most-favored-nation status to every depositor? And, why should banks be any more obligated to provide consumers with “most favored nation pricing” than cable, mobile, insurance, streaming, etc. companies?
Conclusion
Regulatory expectations for banks evolve constantly, apace of changing societal norms. As a consequence, perfectly acceptable banking practices in one generation can become unacceptable in the next. Regulators often visit their changed expectations on large institutions first, but, slowly, and often in an attenuated form, they spread to the rest of the banking industry.
Banks concerned about getting ahead of this issue might consider at least a couple of steps:
Review deposit marketing and products in advance of any targeted exam to understand potential vulnerabilities;
Review liquidity risk scenarios in which an inequality similar to the one that drew the CFPB’s attention to Capital One makes the front page of USA Today or the lead story on 60 Minutes.
Photo by SevenStorm
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