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How do banks decide to pay interest or charge fees?

Q: My question about banking is pretty basic. Why do banks pay interest on savings accounts, but then charge you fees on checking accounts?

A: First of all, some banks do charge a fee for savings accounts, especially if you slip below a certain minimum balance. So, possible fees are something to watch out for when choosing a savings account, especially if you are making a relatively small deposit.


With that being said, it is true that checking accounts are more likely to charge a fee than savings accounts. The reason is that checking accounts are designed to be transactional. Between checks and debit card charges, checking accounts can have dozens of transactions per month. In savings accounts, access is more limited so as to keep the number of transactions down.

This difference in transaction volume affects the banks in two ways, both of which influence the likelihood of an account charging a fee. For one thing, it costs money for banks to process transactions, so checking accounts tend to be more expensive to handle than savings accounts. For another thing, since people tend to leave money in savings accounts for a long time without touching it, banks are able to put that money to use in the meantime. This has an economic benefit to the bank that helps offset the cost of handling the account.

That economic benefit has been diminished lately by a weak lending and investment environment. This is one reason savings account rates are so low today. So, while you may not be paying a fee on your savings account, the fact that savings account rates are below inflation means you are effectively paying a price to keep your money at the bank.

Besides the fact that banks are not making as much money today, another reason why savings account rates are so low is that banks do not have a strong incentive to offer higher rates to attract deposits. There is actually a glut of deposits these days, and with the federal funds rate at 0.08 percent, banks do not lack for a source of low-cost funds.

Checking and savings accounts do have one thing in common: They could both benefit from an improved economy. In recent years, fees on checking accounts have been rising while interest rates on savings accounts have been falling -- a lose-lose situation for consumers. What could turn this around is a sustained period of economic improvement. This would give banks more profitable ways to use deposits in savings accounts, and thus a reason to pay more interest. In turn, profitable relationships can help subsidize checking accounts, so a stronger economy would take some of the pressure off those fees.

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