Friday, August 13, 2010

This Week in Bank Failures

For the first time, a federal court has ruled on an aspect of gotcha banking, and the ruling goes right to the heart of the gotcha approach. The court ruled that Wells Fargo’s efforts to hide fees from its customers made certain fees unlawful. According to the court, the intentional element of surprise in the fees ran counter to the principles of contract law. It ordered the refund of about half a billion dollars in fees going back to 2004. Wells Fargo has said it will appeal the decision.

The ruling wipes out Wells Fargo’s great innovation in gotcha banking, which had to do with recognizing debit card transactions from largest to smallest, instead of the order in which they occurred. This approach resulted in about five times as many overdraft charges. In extreme cases, it could extract more than $1,000 a day in fees from an account that otherwise would not have had an overdraft at all. Many other banks copied Wells Fargo’s overdraft fee technology, so the ruling is significant for the industry as a whole, and may set the stage for similar suits against other banks, and on other fees.

Regardless of the legal outcome, gotcha was never a sustainable business model. Customers who are stung are less likely to look favorably on the bank in the future. Inside the banks, the gotcha model was always looked upon as a stopgap, a way the banks might dig themselves out of the financial hole they were in. And even this may not turn out to be true if the banks are forced to refund many of their ill-gotten gains.

Another Chicago bank failed tonight. Palos Bank and Trust Company, with five locations and $468 million in deposits, was closed by Illinois banking regulators. First Midwest Bank is paying a 1 percent premium for the deposits and is also purchasing the assets.

Palos Bank had been losing money and had little capital left. It kept a low profile for a bank of its size, aside from being the sponsor of a local half-marathon race.