Your bank is not your friend. Hard to believe I know.
A bank is a business. They are in operation to produce revenues and profits. In most cases those profits are then distributed to the shareholders, the owners of the bank.
Banks are an unavoidable need in modern society. So it is worth understanding what their motives can be. In this post I am going to explain why a bank may or may not have your best interests in mind.
What is a Fiduciary?
In finance, law and medicine the term fiduciary has significant importance.
First: “one that holds a fiduciary relation or acts in a fiduciary capacity.”
Second: “relating to, or involving a confidence or trust….”
The way to think about a fiduciary is that they act on behalf of a person or organization. They must put their clients’ interest in front of theirs. The idea is they have a duty to preserve good faith and trust.
Lawyers have a duty to represent you in the best way possible. Doctors must treat you in the best way they can. But in finance that is not always required and so not always the case.
In House Products & Services
In general banks offer similar services. Checking/savings accounts, certificates of deposits, loans, and credit cards to name a few.
When we use these products. They make money.
Checking and savings accounts make money in two ways. Either charging a monthly “maintenance” fee or other fees such as overdraft, wire, safety deposit and ordering checks.
Certificates of Deposit, loans and credit cards generate revenue for the bank by the interest spread. The banks get funds from customer deposits, they then lend them out to other customers and make the difference on the interest paid.
Here is a quick example:
You deposit money into your bank account and they pay you a small bit of interest, say 0.05%. They then take that money and make a car or home loan at a higher interest rate, say 3.0 - 6.0%. They profit by keeping the difference of 2.5 - 5.5% for themselves.
There is nothing wrong with this business. You just need to be aware that this is how they make money. The probability is high they are not going to alert you that a competitor can offer you better terms on your deposits!
This leaves you to do your own research or assume that they are giving you a competitive deal.
Let’s talk about the advice you receive from a bank.
Banking culture varies when you look at each player in the market. Even more confusing is the culture which can vary from branch to branch. Depending on the size of the player it can be a gift or a curse.
When dealing with smaller players like community or regional banks there may only be one or a few branches. This can help you determine if how that bank operates fits your needs.
Are they more focused on business and corporate accounts? Do they have a strong lean toward nonprofits? Things like that matter.
Dealing with the larger players can be more challenging. They have hundreds and often thousands of branches
. Because of this you run the risk of getting advice that may not be in your best interest.
One of the most glaring and ultimately fraudulent examples of this is Wells Fargo in 2016. Wells Fargo culture at that time was driven by “cross selling”. The concept is that employees would try to sell many products to current account holders.
example: You have a checking account but they would try to get you to sign up for more. Credit card, mortgage, etc. even if you do not need it or request it.
Wells Fargo employee rewards and compensation were based off of how many products customers signed up for. Your account(s) even fell in a pecking order depending on how many products you had. More was better.
It is not hard to see how this system could turn into a problem. In this specific case accounts were even being opened without customer consent! Customers only found out about these accounts when they saw fees for accounts they did not know they had!
The news of this broke and Wells Fargo has now paid billions in fines. To many, their reputation has taken a hit and may never rebound. If you want to get the full story this Wikipedia article
sums it up.
I bring this up because it is the highest degree of not acting like a fiduciary. Their culture at the time was breeding and empowering employees to do the wrong thing.
Currently there are no national laws outlining when and how a bank needs to act as a fiduciary. Until that happens you unfortunately must be a skeptic of your bank’s motivations. We encourage you to always double check and possibly get a second opinion.
Suitability & Fiduciary in Investing
Investments are one area where a bank may or may not need to act as a fiduciary. This depends on if the bank’s investment arm is a Broker-Dealer or Registered Investment Advisor (RIA).
Generally speaking if you work with a Broker-Dealer, commission is how they get paid. They are not required to act as a fiduciary. What they have to do is act and fulfill their job with the mind of ‘suitability’.
Suitability is simply answering the question, “Is this appropriate or suitable for this specific client?”
. The definition of ‘suitability’ comes from FINRA Rule 2111
Here is an example of suitability:
An elderly client is living on a fixed income. Due to that they should not own speculative investments like options or futures. The risk profile of those assets is too high. Those investments are not suitable for their current investor profile.
If the above example is too textbook. Let’s talk about what happened with Robinhood and GameStop.
Robinhood was allowing traders to buy and sell on margin with a T+2 trade settlement
. They were fronting the capital to traders. That put Robinhood in a bind because they were using their own capital for client purchases.
They are only a broker-dealer so their responsibility is only to their investors (shareholders). They chose to limit the trading of the stocks and close out trader positions to protect their business. They even raised $1 billion in cash
to shore up their strained balance sheet.
Wells Fargo is an egregious example of not being a fiduciary via fraud. Robinhood is an example of not being a fiduciary by protecting their own investors first.
If who you are working with for your investments is a Registered Investment Advisor (RIA). They are then required by law to act as a fiduciary. This comes from the Investment Advisor Act of 1940
. This means they are subject to regulation by the SEC or the State in which they operate. They are usually paid by fees and not commissions. Generally, this leads to the incentives of the client and RIA being aligned.
When dealing with who offer investment services our recommendation is to find out if they are a Broker-Dealer or Registered Investment Advisor (RIA). This will help you solidify that the advice and investment options are in your best interest.
No matter if you love or hate banks. You need to work with them in modern society. Understanding when they act as a fiduciary is critical to the relationship. Especially if you work with them for your investments.
A little research and due diligence will go a long way for you. Please spend the time to understand the bank you work with. If they do not meet your needs. Look elsewhere.
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