Rethink Early Withdrawal Penalties to Create a Win-Win for Banks and Their Customers
Banks have historically used simple perks — cookies, coffee, gifts — to attract depositors, many of which are now worn out as differentiators. What relationship sweeteners are available today? Here's one idea that's safe and profitable for a bank and that creates loyalty with savers.
By Neil Stanley, CEO and founder of The CorePoint
With interest expenses at all-time highs, banking executives are looking for ways to add value for depositors without spending more on deposit pricing. Yet, most tactics used to sweeten the relationship – cookies, coffee, and even branded swag – are well-worn.
The question behind these relationship sweeteners has never been more critical. Acquiring preference with coffee – a value not tied to interest rates – costs less than acquiring depositors’ preference with deposit pricing. What’s today’s coffee and cookies?
What can banks give in the banking relationship that gets more than it costs? Banking executives must look for opportunities inside their deposit product design to find win-win opportunities.
Where’s the Give that Gets More?
Interest expense has traditionally defined the value of service give-get trade-off because it aims to use non-financial perks to influence depositors.
Every dollar of deposits acquired because of the cookies – instead of a 25- or 50-basis-points increase to their deposit prices – significantly impacts account profitability. If a $1 cookie causes a depositor to think, "I like how that bank operates" instead of demanding rate matches, that’s $24 in savings when they don’t secure a 25-bps bump on their $10,000 in savings over a year.
Cookies, however, lost their appeal in differentiating institutions some time ago. Frontline charm and hustle, while still valuable, have become less definitive factors in this complicated world. That’s not to say institutions have not developed new ways to differentiate service; the traditional service sweeteners are less impressive, and they’ve become so evenly distributed through banking.
Recent interest rates history has not been kind to banking’s cost of funds. Banks and credit unions have some $3.5 trillion in certificates, for example, many of which originated during a high-rate environment, and many will take some months to mature. Interest expense for banks now sits at historical levels, has exceeded non-interest expense, and become a material drag on banking earnings. Banking institutions need to find savings. Where might they look to build service give-get trade-offs that generate the loyalty that saves deposit cost?
That word, savings, provides direction. Executives want cost savings, but they will only find loyalty trade-offs that create it when savers "like how the bank operates." So, what’s not done today, that’s safe and profitable for a bank and that serves savers’ interests?
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When Interests Align
High interest rates during the last two years motivated savers to move money previously parked at a low rate into a certificate. Others were already certificate users and utilized higher rates as they became available. Both groups are now in certificates, some for terms longer than a few months, at rates above 4.5% or even above 5%.
With rates now down, institutions are stuck. It appears there’s no opportunity to sweeten the relationship with service because there’s no seemingly positive give-get trade-off. The depositor got a great rate and locked in; it’s a hold-to-maturity incentive for those savers.
But what if something unexpected happens? What if the depositor changes their mind about the goal for their savings? What if they begin making more money, for example, and decide to buy a home, or a car? Then the bank has a depositor in a 5% certificate who may want some or all the funds. The bank also would prefer not to pay all that interest from a purely financial standpoint.
Why assess an early withdrawal penalty in this situation?
When this depositor gets what they want (early withdrawal), banks get what they want: Interest expense savings. Assessing penalties more intelligently offers a give-get trade-off in the moment of withdrawal, and in depositors’ minds long-term. They’re encouraged to see their institution as a better place to be a saver and perhaps a place where options are more important than 25 bps rate bumps.
So How Much More Profit Is There, and Is It Safe?
Generally, waiving early withdrawal penalties is safe and not unusual. But before we look at that closely, let’s do the math: Is it profitable?
Consider that depositor with 12 months remaining on a CD at 5.2% with a current balance of $100,000 again. If the CD reaches maturity, the interest expense to the institution will be $5,200. Suppose the depositor needs the funds, and wholesale rates are now at 4.2%. If the depositor withdraws early, the total possible benefit to your institution is about $1,000 because you can replace the funding at 4.2%.
Given the example above, the arbitrary early withdrawal penalty of this or that number of days’ interest actually prevents interest savings. It also acts as a barrier for people wanting to access their CD money. The point here is not that institutions should waive penalties. They happen to cost institutions, literally, in situations where the institution could benefit depositors AND gain profitability.
Should banking institutions set a precedent of simply waiving penalties? Probably not. So, how can they adapt their approach?
Decades ago, banking adopted its CD penalty structure because it was easy to calculate. But they only needed that simplicity because CDs were created before we had calculators. You read that right – before calculators. Still, the structure made it clear and transparent how certificates worked for everyone, staff and depositors alike.
Why not get rid of the bad and keep the good? Keep the structure (structure preserves scalability) and drop the arbitrariness so that the institution creates more win-win scenarios for the bank and depositors.
For that $100,000 CD at 5.2%, the $1,000 in savings is possible for the bank because wholesale funds were down to 4.2%. The bank can calculate replacement cost easily. Why not benchmark CDs’ early withdrawal "penalty" to wholesale funding and publish a total withdrawal balance daily? Then you never have to talk about fixed penalties, and you improve CDs’ performance in any rate environment.
How to Get to ‘I Like That Bank’
Banking executives will have seen this process before: Institutions buy and sell U.S. Treasuries with similar optionality. If you buy a treasury before rates rise, you will probably have a "loss" if you sell it – it’s not worth as much. If you buy a treasure before rates decline, you will probably have a gain if you sell it – it’s become more valuable.
Publishing total withdrawal balances opens up CDs because they now have similar options to the treasuries bankers know so well. If a depositor opens a CD before rates rise, they’re no more or less locked in than they were before. Early withdrawal would also not be favorable, just as it is not now for the traditional CD.
But, if the depositor opens a CD and rates go down, they can exit, and banks can choose to share a portion of their interest expense savings with depositors. The CD becomes transparent because of the published withdrawal option. Depositors aren’t confused because online banking shows their withdrawal amount. CDs with this approach will always be the same or better for depositors than a traditional CD. The same would apply to the institution because the structure eliminates the lose-lose of early withdrawal during a rates-down situation.
Now, a possible $1,000 in savings on a portion of an institution’s CDs is an opportunity. But remember, the game here is not just cost savings for the bank; it’s the savers and their savings. Are they encouraged to see the institution as a better place to be a saver? It’s that differentiation that can attract and retain funding without always increasing deposit pricing. That’s how banking institutions revive the coffee-and-cookies trade-off: Give in a way that you get more.
