It`s Fee Time In Banking

In these times of negative savings rates, sub-subprime lending, 125%-of-value home equity loans, record personal bankruptcies, Internet equities priced at several hundred times sales, $200 billion trade deficits with rising interest rates, and global economic disasters, bank directors and officers have enough evidence of increasing risk to factor it into their strategies. (Incidentally, this may be the longest sentence of my career but it’s worth every word.) Banks, of course, make money when there are few bad loans and do poorly when bad loans rise. Unfortunately, the days of increasing sour loans can’t be too far away.

Each time the economy turns, the financial industry’s attention moves from spread income to fees. Not that fee income hasn’t been in every good bank director’s mind in recent years, but its real merit becomes even more evident when borrowers begin to default.

Fee income has been on the rise for the last decade, and large banks have raised the bar to the point where some of them are reaching 40% in noninterest income.

Selling customers fee-based products is a service if it provides them with a tangible benefit they really need. If, however, customers are charged fees on services that previously were free (such as ATMs), the reaction will be somewhat different. It’s important to remember that the bank’s customer base is the only real asset it possesses (when we sold failed banks at the RTC, the salable parts were customer deposits, along with a few loans). Thus, if a bank provides new services, it is taking steps to strengthen its basic asset: its satisfied customers.

The two areas that promise the most significant increases in fee income for banks are, I believe, insurance sales and what’s often referred to as “managing other people’s money.”

Recently, BAI and Boston Consulting completed a study that concluded that insurance sales promise the largest increase in fee income for banks, particularly those in smaller asset sizes.

All kinds of insuranceu00e2u20ac”life, health, property and casualtyu00e2u20ac”can be sold profitably by banks. Many insurance underwriters have found that the bank platform is the most efficient base for selling insurance. In a few states (like Maine), banks are already among the largest insurance agents.

This movement toward insurance is at least in part due to the longstanding Glass-Steagall restriction on selling equities. For whatever reason, managing pension funds, 401(k)s, personal savings, trust funds, and charitable holdings has become a growth business that far exceeds lending. If Social Security funds are to be invested in privately controlled equities (as has been proposed by the Republicans in Congress), the money management business will become the growth prize of the financial industry.

The management of other people’s money has always been a part of the banking business. In fact, when the trust business was in vogue, money management really was centered in the banks. But now, with mutual fund companies and investment bankers in the lead, the banks have lost out in the fastest growing part of the financial industry.

Getting into the business today takes some real strategic study. Again, the need for banks to move with speed to acquire money managers is present, since the number available for sale is much more limited than companies in the insurance sales field. The upside of the business is that if equity investing is down, fixed income is likely to be up. The potential to combine personal investment advice with other investment services profitably is good, because a bank’s investment services are personalized, not a commodity product, and are thus subject to less pricing pressure than other areas.

Unless I’m wrong, which of course is seldom, the time for caution in lending and for increasing fee income, particularly from insurance and money management, is here.

If the new bank legislation (previously H.R. 10) is passed this year, it should make breaking into insurance sales even easier. (With Secretary Rubin retiring, the chance of a modernization bill passing, I believe, has increased, as the battle between Treasury and the Fed has tilted in favor of the uncompromising Chairman Greenspan.)

Getting into the insurance sales business is a major challenge, and it usually involves buying one or more independent agencies. And though agencies are plentiful, remember that there are only a limited number of them that are profitable and well run. If these are sold before banks get going, it will be a much greater challenge to sell insurance through the purchase of “second-level” agencies.

So my advice is to get going. Examine your strategy at your next board meeting and don’t let the competition steal all the fee business out from under you.