The Pro’s and Con’s of Rewards Checking Programs
The Pro’s and Con’s of Rewards Checking Programs
Because we have had the opportunity to evaluate the results of several Rewards Checking programs, banks occasionally seek our opinion. Many banks offer the product, and some well-managed banks will tout its success. Like most services and products, results vary depending on cultures and markets. That said, our experience indicates Rewards Checking programs have many pitfalls that we think the banks can and should avoid.
It is important for a bank to be very clear how the program meets specifically defined goals. Banks will be told that the program will increase core deposits, bring new relationships, increase fee income and increase profits. As nice as that sounds, it is ambiguous. In our opinion, combining all of the program’s typical features into one account is fundamentally flawed. One major vendor reports the collective average balance for 55% of the accounts in the program is only $800. Attempting to raise NSF and interchange income in a product that highlights high rates is not an optimum combination. To the extent that regulators will continue to allow banks to do so, NSF income is more profitably acquired through other products and programs. If the goal is to raise deposits, it can be done at lower rates with special promotions or enhanced Money Market accounts without paying a vendor. Free ATM’s are important to some targeted customers but can be accomplished with less expensive strategies. If the goal is to attract specifically identified customer niches, energize the sales force or strictly play defense, elements of the program may be a fit.
Using rewards checking as a panacea to the hard work of a focused and effective marketing plan will prove to be expensive. In attracting new relationships with the program, you will want to know the type of customer you are trying to attract and specifically what about this product will make them choose your bank over another. Features of the product that are not essential to those specific objectives should not be included. Since the cost is high, it is also important to identify and minimize the features that will make existing customers migrate from current products to this one. The challenge is to find the balance of treating existing customers fairly and incenting new ones.
Because they did not have clear objectives and modify the program accordingly, we have observed executive teams reflect buyer’s remorse. Some bankers already under contract cannot articulate the current goals of the program. We have also seen some delay the program for months after signing and had one CEO say his cheapest out is to just pay the monthly fee for the term of the contract and never actually offer the product. It is especially common for banks to dramatically lower rates and tiers after they are in the program for a period of time, and some freeze it altogether. Sadly, this is after having converted a high volume of existing accounts and deposits to the more expensive product.
Even though some will not “qualify” for all the benefits, typically every customer is eligible for this higher cost checking account without barriers to prevent migration. The typical analytics and standard reports we have observed do not isolate the real and identifiable increased cost for higher interest, additional vendor expense and lost fee income on the balances and accounts that migrate. These costs dilute the marginal profitability of the newly acquired relationships. The standard reports typically do not include calculations reflecting how the new program impacts ROA and ROE. Our research reveals the programs generally have a dilutive impact on these ratios as a result of lower margins, fewer fees and increased expenses, especially from the migration of existing balances. It is typical for existing accounts to make up at least 50% of the total at the end of a year and still 30% at the end of three. Although nominal net income does increase, there is a major difference between increasing nominal income and increasing the return on equity. Attracting large deposit balances on which the bank receives any amount of net income from the spread and fees improves nominal net income. However, when capital to support large balances with low margins is taken into account, the returns often do not look nearly as attractive. Deploying excess capital for positive nominal income would not be bad if it were a temporary event. But when you consider it comes with a long-term contract and was made with a big marketing splash, it can result in an inefficient use of your capital for an extended period.
If you feel this product will profitably attract new core customers, some additional terms will help you mitigate the negatives while achieving your goals. These would include establishing minimum balances to qualify for the ATM fee benefits or other services such as mobile banking or bill pay as well as minimum balance fees. This and requiring direct deposit will reduce migration. Because a product based on a high interest rate should be primarily designed for new relationships with more than minimal balances, these modifications will not serve as a deterrent to customers seeking the higher rate. It will prevent you from having low balance accounts with higher expenses from an additional vendor payment and rebating ATM fees with limited offsetting income. It is especially important to find the minimum balance tier and rate that will enhance sales efforts for the targeted market without migrating substantial existing accounts to the new product. You may even find you have the resources to build your own product internally and deliver the majority of the important benefits without the cost of a new third-party vendor.
Although the vendor agreements and pricing seem to have improved over time, they still have some language you may want to negotiate. Most agreements lock a bank into this program and have penalties or restrictions against a bank’s ability to discontinue the product or substitute it with similar ones. For all of these reasons, this is a decision banks will want to get right.
About the Author
Kelly Karns is President of Karns Profit Improvement®, an independent Oklahoma-based financial consulting firm that has specialized in growing the profits of community banks in a multi-state area since 1986.