Effects of Dormant Accounts on the Profitability of Deposit Money Banks

Introduction

Dormant accounts are accounts that have not experienced activity in the over a prolonged period of time. The exact period of inactivity is often not described and is dependent on individual banks, the jurisdiction that such a bank falls into, and the terms and conditions that they institute to their customers.  According to the Federal Deposit Insurance Corporation (2011), the federal law considers accounts that are more than 18 months inactive for deposit accounts and one year for safe deposit boxes. There are varied reasons that make bank accounts to go dormant or inactive, for instance, the death of the account holder, forgetfulness, opening bank accounts for short term reasons, and dysfunctional income structures among others. 

This paper will look at the process of making an account dormant by bringing in the element of statutory requirements. The paper will also use theories relevant to dormant accounts to explain dormant accounts and the premises that states and banks use to exploit such accounts to their own advantages. Financial banks have their unique way of ensuring that dormant accounts are viewed and put into task as assets that should generate revenue for them. A look at how they manage to do this will be evaluated and the need to have the states take control of dormant accounts rather than have them stay in the hands of financial institutions justified. 

Banks and Dormant Accounts

When a bank account becomes dormant, it becomes the responsibility of the holding bank to establish contact with the account holder or the indicated heir. If such efforts prove futile and the account remains inactive for periods long enough to warrant the account being declared dormant, the account undergoes the escheatment processes according to established laws. To escheat is to transfer the property (financial or otherwise) to the state when the holder of such property fails to make contact or claims against that property. The person in question must also have inactive heirs or no heirs at all. After a dormant account is ‘decommissioned’ it is forwarded to the state which becomes the apparent custodian. The escheatment process is reversible. The account holder after identifying their assets can reclaim their assets from the state. Financial institutions such as insurance companies, brokerage firms, and companies issuing dividends and lotteries have a mandate to escheat such assets should they be declared unclaimed. Deposit money banks feel the effect of having dormant accounts as it shall be discussed in this paper. 

Theories Associated to Unclaimed Assets

Various theories have been advanced to explain how banks use bank balances in dormant accounts to invest and earn out of them. They include the theory of multiple lending, hold-up and soft-budget constraint theory, and the unclaimed assets theory. The theory of multiple lending implies that banks are able to have deposits which are often several times bigger than the cash base. As explained by Carletti, Cerasi, and Daltung (2007), the increase in lending ability out of much lesser deposits arises out of deposit multiplication. If a bank has dormant accounts of high value, its capacity to loan out is increased and if the bank is able to actually loan out, its profitability is increased. The hold-up and soft-budget constraint theory as discussed by Maskin (1994) explains how a constraint is created when a funding source, in this case dormant accounts, finds it impossible to keep the concerned bank on a fixed budget. Dormant accounts are not a consistent funding source especially due to the fact they have to be escheated after some time. The time these accounts have to be escheated is relatively short and cannot stand to wait for the payback period to come to maturity. The unclaimed assets theory or simply the theory of escheatment according to Stegman and McKethan (2005) provides that dormant accounts should be used as sources of revenue that benefit the entire public within the concerned jurisdiction until the rightful owner of such assets is traced. In the U.S., the theory of escheatment found its legitimacy on the Uniform Unclaimed Property Act of 1995. The act guides the processes and methodologies of financial institutions handing over dormant accounts and assets to the state and the other way round if the owner has been identified. 

Dormant Accounts: The Catch for Financial Banks

Holding bank accounts that are dormant is something that financial institutions do not like for two reasons. First, banks are closely monitored by states and a slight violation of the rules might attract unwarranted results. Second, when amounts involved are small, it means that banks will spend more maintaining the accounts and get little revenue later. It is a responsibility that comes with costs and need for accountability. There are two types of dormant accounts: those with high balances and those with low balances. Profitability for banks is often tied to the assets they are managing as put by Focarelli, Panetta, and Salleo (2002). The number of assets under management is often a problem especially if the number of such assets is high and the value low. This means that when banks hold many dormant accounts with lesser balances, they eventually get bothered by assets of little value. In the end, banks incur costs managing assets that offer little returns. High balance accounts give banks the chance to manage high value assets that are admirable. In both situations, when dormancy extends long enough to trigger statutory actions, the costs of management increase further as described by Cramer, Black, King, and Hart (2015). In essence, it means that our capitalist tendencies are reflected in banks. Banks will like that which is of value to them. Banks will balance accounts against their value and further attach costs to the activity of holding dormant accounts. Since it is business, banks will eventually be impressed by impressive balances which they can then use to increase their loan multiplier. 

Justifying why the States stick their Hands to hold Dormant Accounts and not the Banks

In an article that appeared in the Forbes Magazine, Philips (2015) captured the answer to this question rather well by extrapolating the theory of escheatment. To begin with, Philips (2015) mentions that it is generally considered safe for dormant accounts to be held by the state rather than by individual banks. The states argue that they need resources to run their affairs for the public and one such resource is the dormant accounts. The states make the laws, and the banks follow them, this is master-servant relationship that allows states to dictate terms to the banks to their own favor. Due to a dire need for revenues, the states have been reducing the time taken by inactive accounts to be escheated. For instance, Pennsylvania, according to Philips (2015), reduced its dormancy period from five to three years in 2014 for most assets in its bid to seal a budget hole. Philips (2015) further explains that Keystone State in 2015 managed to book $655 million from escheats from a meagre $390 million the previous fiscal year. Escheats are welcome to states and even when claiming them, taxes and other fees are deducted by the states. 

Conclusion

In conclusion, the profitability of deposit money banks based on dormant accounts can only be considered in the short-run. There above, the theory of multiple lending, hold-up and soft-budget constraint theory, and unclaimed assets theory have been looked at along with their interaction with escheats. According to the theory of multiple lending, dormant accounts are seen as a source of credit multiplier. The hold-up and soft-budget constraint theory discredits the theory of multiple lending when it comes to dormant accounts by throwing in the element of unreliability especially in the long-run. The unclaimed asset theory, on the other hand, gives legitimacy to the authorities to take up dormant assets and use them for public good. States in a more liberal view are interested in dormant accounts and assets just for the purposes of their own good. Banks can only have the escheats for a limited period of time out of which they surrender such assets to the authorities who make money from them without considering the owner of such assets when splitting the revenues.

References

Carletti, E., Cerasi, V., & Daltung, S. (2007). Multiple-bank lending: Diversification and free-riding in monitoring. Journal of Financial Intermediation, 16(3), 425-451.

Cramer, R., Black, R., King, J., & Hart, P. (2015). Addressing the Challenge of Account Dormancy in Youth Savings Initiatives. New America

Federal Deposit Insurance Corporation. (2011). Lost and Found or Safe and Sound: How to Solve Mysteries of Old Bank Accounts. FDIC Website. Retrieved from https://www.fdic.gov/consumers/consumer/news/cnsum11/lostandfound.html

Focarelli, D., Panetta, F., & Salleo, C. (2002). Why do banks merge? Journal of Money, Credit, and Banking, 34(4), 1047-1066.

Maskin, E. S. (1996). Theories of the soft budget-constraint. Japan and the World Economy, 8(2), 125-133.

Philips, K. (2015). Banks Quick to Turn Over ‘Abandoned’ Assets to Revenue-Hungry States. Forbes Magazine. Retrieved https://www.forbes.com/sites/kellyphillipserb/2015/06/17/banks-quick-to-turn-over-abandoned-assets-to-revenue-hungry-states/#5930f8aa5baf

Stegman, M. A., & McKethan, A. (2005). Escheats Funds: An Overlooked Source of Public Capital for Busines Development in North Carolina. Center for Community Capitalism. Kenan Institute of Private Enterprise. The University of North Carolina.