Describing the current market for deposits as challenging is an understatement. Marketers and retail bankers at banks and credit unions are reviewing traditional strategies in an increasingly a turbulent and volatile market. They’re also looking for tools that will allow growth, regardless of whether it’s a rising-rate, falling-rate or even a zero-rate environment.
In this process, the four basic retail funding options are coming under scrutiny. As described by Greg Wempe, Chief Client Officer for Kasasa, each of these options has its pluses and minuses.
- Non-customer funding such as Federal Home Loan Bank advances are low-cost, but examiners aren’t really thrilled with these types of strategies. Regulators always prefer “core” funding.
- The good old CD let’s you pay an above-market rate, but in a falling rate environment this becomes questionable because it’s hard to be rate attractive when you’re not sure where the bottom is going to be.
- Money market deposit accounts offer more flexibility in terms of being able to lag the market because they’re liquid. But a very big hot-money component can come into play even over 5-10 basis points.
- The core demand deposit account — what everybody wants. The biggest challenge most institutions face here is trying to differentiate in the ubiquitous world of free checking.
The average checking account in the U.S. today is about $1,800, says Wempe. So if a bank or credit union is looking to add $10, $20 or $50 million in deposits, trying to meet that goal $1,800 at a time is really tough, especially when you consider that the lifespan of the average checking account is six years.
Wempe, who spoke during a webinar sponsored by The Financial Brand, says a hybrid type of deposit product, such as reward checking, could provide another useful tool in the current environment.
A typical reward checking account would have such features as:
- Free account — 87% of consumers are still making their decision on their DDA relationship on the word “free.” And so if it is not free you just decreased your potential market to about 13%.
- Rewards — One option is high interest and ATM fee refunds.
- No minimum balance.
- Pays 3% on balances up to $25,000, 0.55% on balances over $25,000 and 0.10% if certain criteria are not met.
Those failing to qualify still earn interest, Wempe notes. The regulators require that. But in the example above, the institution wouldn’t have to pay more than five basis points. “Nobody signs up for a rewards account because you’ve got the highest rate for non-qualification,” Wempe states.
How Rewards Checking Meets 3 Key Retail Banking Goals
The qualification criteria for any new type of deposit account should meet at least one of three goals: make the institution money, save the institution money, or make the consumer relationship stickier.
Wempe describes how a rewards-based deposit account can accomplish all three.
- To make money the institution adds qualifiers like a debit card usage minimum. For example, ten debit card transactions that have to post and clear over a certain period of time. That drives interchange revenue.
- To save money a bank or credit union can require electronic statements for the rewards account. The average institution today pays about $2.15 per month for every paper statement to go out the door, Wempe notes, and 84% of consumers never even open the envelope.
- Banks and credit unions can increase stickiness by getting rewards account holders signed up for, and engaged with, digital products such as bill pay, online banking or mobile banking. All bring a level of engagement beyond normal day-to-day transactions.
Retail banking executives can use the interest rate and the deposit cap to control the average balance of the deposits that come in the door as well as to enable their institution to offer an aggressive rate that will attract attention.
Wempe notes that for the average free checking account in the U.S., about two thirds of account holders have direct deposit or ACH direct-debit set up, while 80% of rewards checking account holders have these features.
“Rewards that are tied to behaviors can pretty compellingly change the type of customer activity,” Wempe notes, “and ultimately drive results to the bottom line for the institution.”
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One Community Financial Institution’s Results
Bank and credit union executives typically think in terms of cost of funds. It’s a key measure, but Wempe says one institution Kasasa works with uses a “cost of deposits” (COD) indicator, which incorporates both non-interest income and expense reduction associated with a deposit product. Wempe walked through an actual example of COD in use.
The institution he highlighted has just over $52 million in reward checking deposits with a promoted interest rate of 3.50%. The amount of interest that was actually paid over the course of one month was $91,490, which computes to an actual cost of only 2.1%. That’s because not all account holders qualified for the full 3.50% rate. Some were above the $25,000 cap and received 0.50% on those funds.
From a pure interest expense standpoint 2.1% would be viewed as very high, says Wempe. But if you bring into the equation the non-interest income component, and the reduction in non-interest expense — which many institutions don’t do — you would see that this institution grew $52 million dollars at a net negative cost. (Wempe walked through this in detail on the webinar.)
Not all banks and credit unions are interested in growing core deposits at any given time. But even if they’ve got a collection of CDs that are getting ready to roll off, and marketers are struggling with how to retain those deposits at a reasonable cost, rewards checking is a potential option, Wempe maintains.
Low Levels of Cannibalization (Depending on Rate)
If a bank or credit union launches a rewards checking program in a market where one doesn’t exist, consumers will ask, “Is this rate something that we can count on?” “You always want to set a rate at a level that you’re not going to change for six to 12 months after launch,” Wempe advises. “You don’t want to introduce a concept to your consumer base that’s going to disappear, like a teaser rate.”
Cannibalization between core and rewards checking is quite low, Wempe states. In Kasasa’s experience, it’s typically less than 10%, unless there is a 200 basis point or greater difference in the interest rates between regular free checking and rewards checking.
Another option to consider is adding a rewards savings account paying a premium rate that is linked to rewards checking. Many consumers don’t want to accumulate too much money in a checking account, Wempe observes. The result can be an overall net increase in new funds as people bring in outside money into the savings account even though its rate may be lower than the premium reward checking rate.
Cushion In a Falling-Rate Environment
During the last period of declining interest rates, banks and credit unions that were offering rewards checking and savings say that because these accounts provide a cushion between the advertised yield and the cost of funds, they had a little bit more control and flexibility, according to Wempe. In fact they were able to watch and wait before reacting to a drop in the Fed funds rate. And then they might make one rate cut while the rest of their competitors made two or even three.
Helpful tip: If you’re looking for an aggressive reduction in net cost of funds and deposits, start with your cap first as opposed to your advertised rate. The reason: The cap is a far greater controller of your overall interest expense.
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Solution to the Rewards-Marketing Challenge
The number one challenge institutions face in implementing a reward checking and savings program is trying to figure out the marketing. That’s one reason why more institutions haven’t done it, Wempe allows.
“If you want to launch a CD to grow deposits,” he states, “you run some ads in the local paper. “But if you’re going to grow deposits from a rewards checking type account it’s going to take something different.” Most community financial institutions don’t have a large enough customer base to do the kind of A/B testing that larger institutions can routinely do for products like this.
What’s changing that, says Wempe, is data-enabled marketing. Many new capabilities now permit smaller financial institutions to take their marketing dollars further and to have a much higher degree of confidence in what the results are going to be. External local market data is readily available from a number of different sources, Wempe notes, and can be combined with internal transaction data.