October 15, 2020
Your Bank Account Pays Negative Interest

Your savings account isn't a passive income stream. It's a monthly expense. Banks are draining your wallet every day, because they can.

Everyone knows banks are essential tools for moving and storing money and managing credit, and that gives banks leverage.

But with the introduction of permissionless money, and increasing consumer demand for online financial services, that leverage is starting to disappear.

You Are Paying Your Bank

Interest rates have been at historic lows through the 2010s, and nobody expects to get rich from their bank account cash balance.

But I'd wager that most of America would be surprised to discover they are actually losing money every single month to their bank.

I'm not talking about some 'nominal expense', where bank interest rates are simply lower than overall CPI inflation (but still positive), leaving you with less purchasing power but more actual dollars.

No, I'm talking about a real expense. Every month you are paying actual dollars to your bank as a service fee, and every month, you are getting fewer back in interest. You are losing real money every month.

This is what three of America's most popular banks pay in annual interest:

This is what those same three banks charge in annual fees:

Assuming the average American family has $40,000 in savings, they're only earning $4 per year through their checking or savings accounts. Not nearly enough to offset the $120+ fees they're paying to their bank.

And $120/year in fees is only the starting price for a bank account. Each of the banks above also charges additional fees for wire transfers, non-bank ATM usage, overdraft fees, and other fees that can quickly dwarf the base account fee.

Although some banks will waive their base monthly fee if certain conditions are met (monthly balance minimums, monthly debit card transaction minimums, etc...), in my six years of personal experience I found that $10-12 per month was roughly my cost to use a bank in America.

Millionaires Don't Break Even on Banking Bills

For someone earning 0.01% and paying $120 per year in banking fees, it would take a cash balance of $1.2 million to break even on their banking bills. Anything less, and you're paying the bank every month.

Of course nobody with a net worth of $1.2 million would leave it all in a cash account, but the point is to illustrate just how useless checking and savings accounts are.

In fact, the terms 'checking' and 'savings' no longer have any meaning. At Wells Fargo, it doesn't matter whether you want a "portfolio checking account", a "preferred checking account", a "Way2Save savings account" or a "opportunity savings account".

You're getting 0.01% no matter what.

Your Bank Doesn't Even Pay The Risk Free Rate

In business valuation, the yield on US government bonds is often referred to as the "risk-free" rate of return. That's because the US has a special mechanism to prevent a default on their debt obligations. They can print money at will.

And since the US Treasury Department is the only entity that can legally print US dollars, it follows that the "risk free" interest rate should be the lowest interest rate in the economy. After all, no other business or local government can print money in a time of need.

But the risk-free rate isn't the lowest interest rate in the economy.

The lowest interest rate in the economy, and the only negative rate around, is the interest rate your bank pays you.

Note: There is currently over $16 trillion of negative-yielding debt in the world, but consumers aren't interacting with any of it.

For consumers:

The only time regular people interact with negative interest rates is when their bank is taking money from them.

Why Is Your Bank Rate Lower Than The Risk-Free Rate?

On the surface, this doesn't make sense. Surely there must be a higher risk of your bank defaulting than the US government. And there is.

That's why the FDIC (Federal Deposit Insurance Corporation) exists. From the FDIC website:

The FDIC (Federal Deposit Insurance Corporation) is an independent agency of the United States government that protects you against the loss of your insured deposits if an FDIC-insured bank or savings association fails. FDIC insurance is backed by the full faith and credit of the United States government.

The FDIC is basically the government's way of protecting you from bank failure, giving you access to their money-printing powers in case of bank default. But the FDIC has limitations too.

Most importantly, the FDIC only protects consumers up to a maximum of $250,000 per depositor, per FDIC-insured bank, per ownership category.

For anyone with less than $250,000 in the bank, you could make the case that the risk of leaving your money with your bank is similar to the risk of leaving your money with the government.

But for anyone with over $250,000, the risk of losing your bank deposits begins to rise.

So why don't higher interest rates translate to the real world as compensation for higher risk?

FDIC data shows that the average interest paid out by insured depository institutions is only 0.04% for checking accounts, and 0.05% for savings accounts today.

Additionally, these rates have never exceeded 0.1% at any time in the last 8 years.

Meanwhile, 3-month Treasury Bills currently yield 0.09%, twice as much as a bank account yields. And in early 2019, T-Bill rates were as high as 2.4%, 23x more than the 0.1% bank accounts were offering.

Why Do Banks Pay So Little Interest? Because They Can

Imagine taking your friends to a nice restaurant for a steak dinner.

It's your turn to get the bill, and it's $1,000. You pay it, and give the waitress a $0.01 tip.

It's not illegal, but it's widely frowned upon (in North America at least), and is well below the market rate for restaurant service.

The only recourse a restaurant has is to refuse to serve you the next time you show up for dinner.

Now imagine that you and your friends are the only customers in town. All of a sudden, when there are no alternatives, the restaurant must take whatever tip they're given.

Maybe one of your friends will offer a slightly higher tip when it's their turn to pay, but you're all good friends and you can easily work together to standardize the tips you offer each visit.

That's kind of how the banking industry works.

Banking: The Only Game In Town

Banks control your access to secure asset custody, credit, and investing.

And while people have multiple banks to choose from, they all work basically the same. See the interest rate comparison above if you don't believe me.

The banking industry has historically been an oligopoly, with a handful of well-known banks offering identical features, fees, and rates.

In America, it's Chase, Bank of America, Wells Fargo and lots of smaller regional banks. In Canada, it's RBC, TD, Scotiabank, BMO, and CIBC.

In both countries, it's a long and costly process to start a new bank. That makes meaningful innovations and product improvements (like higher interest rates) less likely. Banks know they've got a captive market, and competing against each other only lowers their profit margins.

But that's finally starting to change.

New Banking Alternatives

In the last few years, an explosion of 'fintech' tools have emerged to challenge the banking oligopoly.

Some of the innovation can be attributed to permissionless money like Bitcoin that entirely bypasses traditional payment rails.

In other cases, this disruption can be attributed to digitally native financial apps offering far superior user experiences.

None of these solutions have completely replaced the functions of a bank, but they've all built superior products for certain banking use cases.

The unbundling of the bank account is well underway.

Earn Interest (Banks pay 0.01%)

Borrow (Borrowing from a bank is a headache)

Transfer (Sending and receiving wire transfers costs $15 or more at most banks)

Spend (Banks charge fees if you make too few or too many debit card transactions)

Invest (Bank brokerage commissions are typically $5-$10 per trade)

This is by no means a complete list of disruptive fintech products. More than anything, it's an illustration of the shrinking moat protecting banks today.

Banks can't compete on interest rates, fees, or ease-of-use. And while regulation was on their side through the back half of the 1900s, it's much harder to enforce in the age of permissionless money and digital transactions.

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