Part II · Chapter 5 · The House · lesson 3

The second revenue line

11 min

The spread is the business everyone describes. The second revenue line is the one that pays for the branch network, and it is made almost entirely of moments when a customer was not paying attention.

Not fraud. Not even, mostly, unfairness. Published terms, agreed in advance, charged exactly as stated.

Fee income has a property the spread does not: it is close to pure margin.

Lending costs a bank the deposit rate, the write-offs and the capital tied up behind the loan. An unarranged overdraft charge costs the bank the electricity to compute it. Every unit of fee income falls further towards the bottom of the waterfall than every unit of interest income.

Which is why the second line grows in every bank that comes under pressure on the first.

Where it comes from

Charges for going over a limit. Unarranged borrowing, returned payments, missed minimum repayments. Priced at multiples of the arranged equivalent, which is defensible on risk grounds and is also where the largest margin is.

The currency spread. You are quoted a rate to convert money and it is not the rate the institution obtained. The difference is not called a fee, is not itemised, and is frequently larger than the fee charged alongside it.

Interchange. A small share of every card transaction flows back from the merchant's bank to the card issuer. The cardholder never sees it and the merchant prices it into everything on the shelf, so it is ultimately paid by shoppers, including the ones paying in cash.

Packaged accounts. A monthly fee bundling travel cover, breakdown cover and a phone warranty. Some customers use all of it and get real value. Most use none of it, which is precisely what makes the average profitable.

Sending money. Transfers, especially across borders, especially urgent ones, especially at a counter.

Predict

Which of these fee lines would you expect to have the highest margin for the institution?

A monthly account fee on a packaged accountThe spread applied when converting one currency to anotherAn unarranged overdraft chargeA fee for an urgent same-day transfer

A price and a penalty are different objects

Both are amounts of money that leave your account. They are set by completely different logic, and confusing them is how people end up arguing about the wrong number.

Not the same thing

A price

What is charged for a thing you decided to buy.

Measured in: Amount, compared against what competitors charge
For example: A monthly account fee, stated up front, on a product you chose.
Chase it alone and: Compete on it alone and margins fall to nothing, because it is the easiest number in the world for a rival to undercut.

A penalty

What is charged when a customer does something the contract discourages.

Measured in: Amount, times the share of customers who trip it
For example: A charge for going three units over an agreed limit for two days.
Chase it alone and: Rely on it and your revenue depends on customers behaving badly, which regulators eventually notice and customers eventually resent.

Which is which? Put each one on a side.

A monthly subscription for a premium account tier
A charge for a payment that bounced
A higher rate applied to the last portion of a balance carried past the due date
A fixed cost per international transfer, shown before you confirm

The cross-subsidy, stated plainly

Free banking is not free. It is paid for by a minority of customers.

In a typical retail book, a large share of accounts generate no fee income at all. The account fees, overdraft charges and currency spreads paid by a smaller group cover the cost of running everyone's account.

This is worth being fair about, because the obvious framing — the careless subsidising the careful — is only half of it. The other half is that the customers who pay most of the fee income are disproportionately those with the least buffer, which is a distributional fact that regulators in several jurisdictions have found uncomfortable and have acted on.

Both things are true. The cross-subsidy is what makes free accounts possible for people who could not afford a monthly fee. And it is funded by people who frequently could not afford the charge either.

Check

A bank redesigns its overdraft: instead of a fixed charge per day over the limit, it applies a single high interest rate to the amount overdrawn. Fee revenue from that line falls by 40 percent. What is the most likely reason?

Customers went overdrawn less often once the charge changedThe old structure charged the most to people who were over by small amounts for short periodsThe new rate is lower than the old oneCustomers switched to other banks

Who pays, who benefits, who carries the risk

Who pays. A minority of customers, concentrated among those with the thinnest margin for error, plus every shopper indirectly through interchange priced into retail.

Who benefits. The institution, on a line with almost no cost underneath it. And the majority of customers, who receive an account that would otherwise carry a monthly charge.

Who carries the risk. The customer, in the specific sense that the cost is unpredictable and arrives in the worst month. A fee structure that is proportional to inattention is a structure whose bill is largest exactly when someone was least able to pay attention.

Worth remembering

Fee income is close to pure margin, because almost no cost sits underneath it, unlike interest income.
The most profitable charges are the ones not presented as charges, such as a currency spread, because they cannot be compared without effort.
A price is chosen and comparable; a penalty is triggered by inattention and its revenue depends on how many customers trip it.
Free banking is funded by a cross-subsidy from a minority of customers who pay fees.
Charges structured as a flat amount collect far more from small, brief overdrafts than a proportional interest rate does.