Focus On Two Key Areas to Capitalize on Overdrafts


overdraft-10-16-18.pngBy all accounts, the outlook for overdraft programs is encouraging for community banks.

Increasingly more consumers are choosing to access the service as a short-term funding solution, while regulatory burdens are easing. Banks that manage their customers’ overdrafts with outdated programs—those that do not put their account holders’ best interests at the forefront or utilize outdated technology and procedures—cannot capitalize on this real opportunity to improve service and compliance, as well as fee income.

The Overdraft Landscape
According to Moebs Services Inc., an economic-research firm, overdraft revenue increased 3 percent industry wide from 2016 to 2017, the largest increase since 2009, and is on pace to an all-time high above $37 billion by 2020.

One reason for this increase in overdraft fee income is more consumers are making the decision to access the service when funds fall short. Moebs Services reported there were approximately 1.12 billion overdraft transactions in 2016, up from nearly 1.09 billion in 2015. According to a 2017 Wall Street Journal article, these numbers suggest many consumers consider overdraft a safety net—a convenience—for which they are willing to pay a price. Analysts said in the WSJ article that the increase in overdraft revenue should be expected, since rules and regulations have been in place for some time now.

In addition, the Consumer Financial Protection Bureau withdrew overdraft rulemaking from the agency’s spring rulemaking agenda in May after having been on the agenda for years, signaling that no new overdraft regulations will be forthcoming.

With this landscape set, how should your bank capitalize on it?

A Data-Driven, Automated Solution
The first place to start is to review your current overdraft procedures and software capabilities to ensure you are using a modern, data-driven solution—one that automatically manages risk and strives to meet customer expectations. Although there are several essential components of such a system, two are listed below.

Intelligent Limit-Setting
Updated automated overdraft programs should enable your bank to set individual overdraft limits that align with an account holder’s ability to repay the overdrawn balance. The software analyzes the key risk variables of your accounts, identifies the accounts that have the highest probability of charge off and calculates individual “intelligent” limits. It then reassesses that ability to repay daily.

Providing these dynamic limits helps to serve customers better than employing fixed overdraft limits (where the same overdraft limit is assigned to every customer of a certain account type) by granting higher overdraft limits to those customers whose ability to repay warrants it, while pulling back on those who have more limited repayment capacity.

Just as important, using intelligent limits addresses the Federal Financial Institutions Examination Council (FFIEC) 2005 Joint Guidance on Overdraft Protection Programs, which states, “Institutions also should monitor these accounts on an ongoing basis and be able to identify consumers who may represent an undue credit risk to the institution. Overdraft protection programs should be administered and adjusted, as needed, to ensure that credit risk remains in line with expectations.”

Reg. E Outreach
Eight years have passed since most banks conducted a formal outreach program in response to the 2010 Amendment to Regulation E, or Reg. E, which requires affirmative consent from customers for banks to charge an overdraft fee on ATM and one-time debit card transactions. Does your board know the number of customers who did not provide a decision back in 2010 or at a subsequent account opening?

Without consent, banks do not extend overdraft privilege through these channels, which can result in multiple unexplained debit card declines. Customers may not recall making a Reg. E decision or are unaware it is even an option, which leads to confusion and irritation for the customer.

Data-driven overdraft software allows your bank to identify these denied transactions and sort them by a customer’s Reg. E decision. With this knowledge, you can reach out to those customers who have not provided a decision and explain the reason for the denial, offer overdraft alternatives and obtain a Reg. E preference. Customers appreciate this level of communication, which provides assurance your debit card will consistently help them meet their liquidity needs.

Capturing just a few percentage points more Reg. E opt-ins can result in a tangible increase in both interchange and fee income as well. A qualified third-party overdraft provider will offer employee training, best practices and scripts to ensure your Reg. E outreach program is successful and compliant.

Is your bank positioned to capitalize on the opportunity for better service and income that a well-run overdraft program represents? With the right technology and procedures, you can.

Boosting Income Without Losing Customers


The Durbin amendment and new overdraft rules significantly cut into fee income, creating more unprofitable accounts. So what should banks and other financial institutions do to generate more fee income? StrategyCorps’ managing partner Mike Branton talks about how financial institutions can increase fee income from these accounts without scaring off profitable customers.

What are banks doing today to get more checking-related fee income?

There are three camps. One camp continues to do nothing. Maybe they think overdrafts are going to make a comeback.

Another camp is doing what we at StrategyCorps call “fee-ectomies”—charging for things banks have been giving away for free or relying on past tactics like balance requirements with penalty fee (maintain a $500 minimum balance or be charged $6). These fee-ectomies are perceived as unfair by customers—paying fees while adding nothing of value. Economists describe this as “an unfair value exchange.”

The third camp recognizes that consumers have been trained to value traditional checking benefits at zero due to free checking; that perceived fairness drives customer reaction to fees; and that you must not make the same checking account changes across the board with no recognition of the individual customer’s existing relationship profitability with the bank. We think the third camp will be the winners financially and with their customers.

What specifically is this third camp of banks doing?

These banks have first found a way to understand which checking customer relationships are profitable and which ones aren’t. Doing this allows for checking account changes to selectively fix the unprofitable ones and protect the profitable ones, rather than a wholesale change that may raise fees on every customer.

Once the banks have this identification and segmentation, the account design changes include adding non-traditional benefits if you are going to add a checking fee. Adding a fee without blending in new benefits results in customers feeling their bank is just greedy by charging for things that have been given away for so long. Think about how you feel about when airlines charge for luggage.

Third, once banks have determined the precise checking account changes to each customer segment, they should communicate these changes clearly and directly to each customer with an “upgrade” message rather than a “we need more fees but aren’t providing you any more value” message. And they train their branch personnel to understand how these changes are truly fair for the customer, so they can deal with inquiries from customers about those changes.

In a nutshell, these three things are what StrategyCorps does for financial institutions.

So I guess you don’t agree with banks or thrifts charging fees for the use of a debit card at $4 or $5 per month?

It’s insane. You’re taking the number one most convenient, most popular way that customers want to pay for something and now you start charging a usage/penalty fee for that card right at the time you need significantly greater transaction volume? This negative reinforcement won’t work and there’s consumer research showing 80 percent to 90 percent of consumers oppose this idea and 20 percent to 30 percent will change banks over it.

With the Durbin amendment (which caps debit fees at 21 cents per transaction for banks above $10 billion in assets), banks have to make it up with volume. So incentivize customers to use it more. We’ve designed our products to do this and are seeing transactions at least double. Charging a fee is going to not only tick off customers but also cause material account attrition that will offset significantly any fee lift.

Aren’t there going to be a lot of customers who say, “I don’t want to pay for a checking account?” Won’t a large number of people call the bank and say, “I don’t want the five dollar account, give me the free one?”

Actually, no. We understand this expectation and concern here by bankers, but we’ve done this account upgrade process hundreds of times. The reality is there is no appreciable negative response and minimal incremental attrition if you incorporate a fair fee-based account.

Doing this will get banks more fee income annually per account—the range is between $60 and $75—from unprofitable accounts, which is usually 40 percent to 50 percent of all checking accounts. Do the quick math; this is a significant number. The financial reward far outweighs the risk of losing accounts that were costing the bank money anyway.

And for the profitable accounts, there are several ways the relationship can be protected with this kind of “fair and upgraded” account strategy that significantly reduces their attrition risk.

What’s Next for Consumer Checking after Durbin?


checking.jpgThe two major checking-related fee income sources have been the targets of regulation. Durbin will decrease interchange fees by about 45 percent (44 cents per average transaction down to 24 cents). Sure, there’s still uncertainty regarding the exclusion for financial institutions with less than $10 billion in assets, but even the most optimistic banker will concede that interchange fees will not be at levels where they’ve been before. Add to that, the estimated financial impact of FDIC and OCC overdraft guidance – a reduction of an additional 15 percent to 25 percent on top of Reg E’s first year negative impact of about 10 percent to 20 percent. So, checking account products and pricing will have to change to adapt to these new rules.

These changes to replace lost fees won’t be popular, given overall consumer sentiment towards banks these days. This challenge is compounded by the fact that free checking has convinced consumers that traditional checking benefits aren’t worth paying for. In the minds of many consumers, since banks have been able to financially justify not charging for these benefits for the last decade or so, no longer doing so is just another “fee grab” by greedy banks.

This means the easy and convenient changes like starting to charge fees for the same benefits that have been free or instituting certain requirements, like minimum balances to avoid penalty fees, is a risky move. It will anger customers, especially the most profitable ones, and chase many of them away to competitors. Plus, history has proven that these kinds of checking changes will generate only a fraction of the revenue that needs to be replaced.

Banks must make changes to their retail checking accounts to incorporate a fair exchange of value with customers. This means an upgrade in what they get when their bank begins charging fees for services. Sorry to sound like a broken record, but charging fees for benefits that customers haven’t paid for in the last decade or adding requirements to avoid a fee is a tough sell, and just defaulting to this approach will be unproductive at best.

So smart banks see the post-Durbin world of checking as an opportunity to launch innovative checking products-including adding non-traditional checking benefits deemed worthy of a charge, such as local merchant discounts and identity theft protection. And look for pricing strategies that simply and immediately reward customers by reducing checking fees based on desired banking behaviors from customers that don’t revolve around minimum balances. This differently defined “pathway to free” will replace the traditional free checking account, which will be hard to justify in the future from a profitability standpoint.