So Wells Fargo is mired in a huge scandal which involved employees opening unauthorized sham accounts to meet sales goals. The culture of fraudulently boosting sales numbers to please company executives was so pervasive that bank employees termed the practice 'sandbagging.' Over the past several years, the bank has fired 5300 employees for opening close to 2 million fake accounts. According to the CFPB, about 75 percent of these sham accounts were deposit accounts, and the remaining 25 percent being credit cards.
Some customers were improperly charged overdraft fees when funds were temporarily transferred out of there checking accounts. Others received credit lines they didn't want, which may have briefly lowered their credit scores by a few points. The bank has pledged to return the fees, and paid a 185 million dollar fine. The main effect appears to be to inconvenience customers, never a good idea for a business where convenience is everything.
If it weren't for the 2008 financial crisis and the residual anti-bank furor, its unlikely we would have seen the grandstanding on display during CEO Stumpf's testimony on Tuesday. The indignation was one step away from chants of "lock him up!" Yes, the firm did wrong, and some customers were hurt, and Wells will need to work hard to repair the damage. But the main 'victim' was the bank itself who was defrauded by its own employees and probably paid millions in unearned sales bonuses. The interesting part of the story however is how Wells ending up shooting itself in the foot in the first place.
There is common misconception among the public and many economists that banks take in deposits and then make loans. Under this view of the world, banks act as mere intermediaries between savers and borrowers. However, in reality, the process works precisely in reverse. Banks create new deposits in order to fund loans by crediting borrowers' accounts. When the new deposit is spent, the payment between banks is settled with reserves which the original bank seeks after the fact on the money markets. The Fed for its part supplies such reserves as are necessary to maintain its interest rate target. Loans create deposits, deposits don't create loans.
For this reason, banks should not seek to increase their deposit base per se. Checking and savings account are valuable to the bank because they are new customer relationships which could result in new loans. But by themselves, they actually hurt bank profitability, and do not enable the bank to lend more. It's always cheaper to seek funding on the money markets. No compliance costs, costly websites to maintain, or customers calling asking about when checks will clear. Indeed, it costs about 40-50 basis points in administrative costs for banks to service their deposits. Retail deposits have become the loss leaders of consumer finance. Banks are paying for a relationship, not borrowing money to make loans.
For this reason, Wells Fargo's strategy of cross selling deposit accounts to existing customers was not just annoying, it made no business sense. They had already paid for that costumer relationship by providing an account. Again, although attracting deposits does not affect a bank's ability to lend, attracting new accounts may bring in new potential customers for loans. But simply opening up a plethora of new deposit accounts for existing customers only creates needless paperwork and makes the already existing relationship more costly to manage.
It was also equally bizarre why Wells Fargo's board praised departing executive Carrie Toldstedt on achieving 'record levels of deposits.' (Shareholders should be outraged over her nine figure retirement payout, but that's for another post) Again, the actual level of deposits held by Wells Fargo are outside its control, and not indicative of the bank's health. For example, say Bank of America runs a successful credit card promotion. In terms of mechanics, bank issued credit cards work just like other loans. The bank issues new deposits, then settles the payments between banks with reserves. A new deposit, created ex nihilo, shows up in the bank account of the merchant who swiped the card. To extent that some businesses have bank accounts will Wells Fargo, a credit card promotion at BofA will actually increase Wells deposit base. But at the same time, to the extent that the public is shifting its credit card usage from Wells to BofA, the bank is actually losing, not gaining market share.
I guess all this is say that the fact that deposits are created endogenously inside the banking sector doesn't just have implications for economic policy and theory, but for running a bank! Unfortunately, the way modern banks actually work appears equally lost on both economists, and ironically enough, bankers.
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