How Banks Will Make Up That $5 Per Month Fee

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Includes: BAC, C, COF, JPM, WFC
by: Dana Blankenhorn

Credit cards.

Credit cards have always been more profitable to the big banks than debit cards have. Most carry an annual fee. They cost merchants 2% minimum in “discounts” meant to assure payment from consumers. They cost more to process. And they carry very high interest rates, rates that can be jacked up if consumers don't pay off their bills in a timely manner.

You almost have to ask why debit cards exist at all. They were originally just ATM cards. It was the credit agencies – Visa (NYSE:V) and MasterCard (NYSE:MA) – who expanded their use into merchant terminals in order to gain a little more money and to save money over check processing. Consumers were happy to switch – how do you feel when you're standing in line and someone in front of you whips out a checkbook?

So the big banks are simply increasing their advertising on credit cards, and canceling ad programs for debit cards. They're also sending out mailers to consumers offing “cash back” on purchases.

That math works like this. Say you're offering to give back 1% of purchases. You do that after six months or a year. Meanwhile you're taking 2% or more from merchants in discount fees, plus interest when people pay less, plus a regular fee for having the card.

Credit card processing has become very consolidated over the last few decades. Small banks and credit unions have moved their business to larger processors, and the financing on these processors is handled by the big banks. Banks have also bought most of the big merchant processors.

It always struck me as tone-deaf, from a business standpoint, that Bank of America would try and charge a debit card fee when there were so many other ways for it to increase profitability within the credit card space.

And if you want to play this as an investor, try Capital One (NYSE:COF). They have the fifth-largest credit card business in the country, twice the size of Wells Fargo (NYSE:WFC). But they're the 14th largest bank in total assets, meaning they're more leveraged to this profitable area of business than their rivals.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I did some checking and found out Capital One is more highly leveraged toward credit cards than other big banks, so I played it that way rather than through the M&A angle. I still think Wells Fargo could buy them.