The BBC reports of moves towards ending free banking in the UK, and charging customers for current accounts. Graham Beale, the incoming CEO of Nationwide says,
In a way, I do believe fee-based banking is a fairer proposition
We might grumble about being charged a fee to have an account, but there appears no logical reason to have ‘free’ accounts, so it must be fair, right?
Well, in our current world of no fees, banks’ costs have to be met from somewhere, usually penalty charges, cheque processing, correspondence etc. These charges tend to be well hidden to most customers. These myopic customers either do not foresee the hidden (high) charges, or see them and anticipate that tehy won’t need incur them, but of course they do.
Sophisticated customers do not make this mistake. They are attracted by the free banking but do not incur the hidden charges because of greater self-control, or perhaps for some services, they find adequate substitutes.
In a free-market, you might think there’s an opportunity for a firm to step up and announce that it will offer a ‘fair’ account charge and no, or much lower ‘hidden’ charges. But as gabaix-laibson.pdf point out in, this might not be the case. Sophisticated firms cream it off the myopic customers on the hidden charges, running the main account as a loss-leader. Sophisticated customers thus ‘exploit’ these myopics because they enjoy free/low cost banking and do not incur the hidden charges; sophisticates therefore, would rather not have a ‘fairer’ (=higher) bank account charge, even if it means lower hidden charges. The final piece in the puzzle is that no firm has an incentive to educate myopics, because they only turn into sophisticates who, by definition, gravitate towards firms offering loss-leader bank accounts with (higher) hidden but avoidable extra charges.
Whether you think this move is right or not depends, I guess on whether you think you’re sophisticated or not. A libertarian paternalist argument might be that most of us will be myopic and firms will earn monopoly profits and not seek to educate us, therefore either the penalty charges should be ‘fair’ (i.e. marginal cost pricing). This seems to be the line pursued by the OFT.
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