Company Case: Southeast Bank: Free Checking?
CHECKING INTO CHECKING
Kelly James, Director of Strategic Planning at Southeast Bank, looked up from her conference table as Bonnie Summers, Manager of Retail Deposits, and Paul Bridges, Retail Product Manager, knocked at her office door.
Come on in, Kelly exclaimed as she waved them in.
I’m ready to hear what you’ve determined on the issue of whether we should start offering free checking. I know there are a lot of pros and cons, and the issues generated a lot of heated discussion around the bank. As you know, the Executive Committees asked me to look into the issue and make a recommendation.
Well, I’ve found some interesting information from a recent national study, Bonnie began. Every six months, researchers at Bankrate.com conduct a national survey of checking accounts, looking at things like fees, minimum balances, service charges, and so on. It recently reported the results of its Fall survey that included 1,276 different accounts at 350 institutions.
The survey found that the interest rate paid on checking account balances fell from a 1.17 percent annual rate to .97 percent. The average minimum balance required to open an account and earn interest was $ 695, a six percent increase in just one year. On the other hand, to open a non- interest- bearing checking account required just $ 76.30 on average, an amount that’s barely changed in three years.
To avoid monthly service fees on an interest- bearing account, you need an average minimum balance of $ 2,434.50, up 5.6 percent in the last couple of years. The average minimum balance in non- interest bearing accounts is just $ 408.16. If you don’t want to keep a high balance in an interest- bearing account, the average monthly service fee is $ 10.85, up four percent per year for the last three years. The average monthly fee on non-interest- bearing accounts actually dropped to $ 6.19.
About one- fourth of the checking accounts also charge per- item fees for various transactions, like check writing or deposits. The average interest- paying account allows 17 freebies, while the average non- interest paying account allows 12 before fees kick in. I also found that ATM fees for non- customers who use a banks ATM system have become almost universal and now average about $ 1.32 per transaction.
Are there any true free checking accounts with no minimum balance, no monthly service charges, and no per- item fees? Kelly asked.
The study showed that about 7.5 percent of the accounts surveyed were free, as you describe it, an all- time high, Bonnie answered. I also found that the number of banks offering free non- interest checking accounts jumped more than 15 percentage points to 45.3 percent. This move was especially true among large banks, like Southeast.
What about insufficient funds charges (NSFs)? Paul asked.
The survey showed that they were at an all- time high, also, Paul, averaging $ 24.85, Bonnie noted. So, it’s very expensive to bounce a check. Many banks offer overdraft protection often for a fee, of course. Some banks charge an annual fee, such as $ 10, for overdraft protection and then add a $ 5 charge each time the customer uses the service.
SOUTHEASTS SITUATION
That’s very helpful, Bonnie. Paul, how would you summarize our situation? Kelly asked.
Competitors have not yet offered completely free checking in our markets, although some are promoting no- fee checking accounts that require that the account holder use direct deposit of payroll checks. These accounts often limit access to tellers. Some banks have used free checking as their number- one weapon in entering new markets and as a result have enjoyed significant gains in demand- deposit accounts (DDA). These banks promote their free checking on an ongoing basis. From a defensive standpoint, we should be prepared for a competitor to launch a completely free checking product in our markets.
From an offensive standpoint, we have the opportunity to be the first in our markets with our own free- checking product. I believe we could realize significant DDA share gains if we advertised the product.
What experience have we had with these products? Kelly asked.
Well, we’ve acquired some small banks that had no- fee products, and we’ve experimented with some limited promotional campaigns in limited market areas, Paul replied. Our free accounts have typically required a minimum balance of $ 500 or there was a $ 9.95 per month fee. The account holder also had to pay $. 35 per item for all checks or debits in excess of 20 per month.
Are these accounts profitable for the bank? Kelly asked.
Profitability depends on several variables, Paul answered. First, there’s the accounts cash balance during the month. Then, we earn income through fees like NSF charges and ATM fees. We give certain credits to the branch that opened the account, which we treat as revenue. Then, we have allocated expenses, non- interest expenses we allocate to every account. If, however, the account has direct deposit, the allocated expenses are about 25 percent lower as it is less expensive for us to handle direct- deposits. That is why so many free- checking products require direct deposits. The savings help offset the lost fees.
Given all that, our study shows that the free- checking accounts we have experimented with had average balances of $ 1,262. Our annual revenue per account from all sources was about $ 274 and our fully allocated expenses were about $ 237, giving us an annual profit of about $ 37. The average account had about four NSF or overdraft charges a year, producing the largest source of account revenue.
I should add, Bonnie interjected, that for our 10 different types of checking accounts, including accounts for students and seniors, the lower the average balance the greater the number of NSF charges, except for our student accounts. Students had less than one-half of the average number of overdrafts.
Okay, what’s the bottom line in terms of the impact on our revenue if we offered a free-checking product just in our home state? Kelly asked.
Our analysis focused on just our home state and estimated that varying percentages of customers from each type of checking account would move to the new product, Paul began. If we offered the account in all 282 branches in the state for all 522,000 accounts, and if our switching estimates are correct, we could lose about $ 4.5 million in various fees (revenue) per year that those accounts are now paying. That is, we would lose this money as our current customers switched from fee- paying accounts to the free accounts. But, of course, we would hope that the new product would draw in new customers to offset those losses, and that those customers would also use other bank products, like home- equity loans or car loans.
Speaking of drawing in, what’ll it cost us to promote this program? Kelly asked.
Our best estimate for an eight- week promotional program is about $ 127,000, Paul answered.
WHAT TO DO?
Thanks for your good work, Kelly responded. This information is helpful. I’ve got to decide what to recommend to the Executive Committee.
I know that free checking is the in-thing now in banking with people believing that free checking gets people in the door. I also know that we make money on lower- income customer’s accounts due to fee income and on higher- income customer’s accounts due to higher balances. Further, although our total dollar balance in our checking accounts has been growing, our total number of accounts has been declining somewhat.
One concern I have is whether or not free checking fits the banks positioning. We’ve tried to position ourselves as a relationship bank, differentiating ourselves based on service versus price. We build and value long- term customer relationships. For that reason, we’ve not tried to pay the highest interest rates or charge the lowest fees because we didn’t want customers who were focused only on price. I’m not sure free checking fits our image. Further, we’ve not traditionally advertised products. Rather, we’ve used corporate advertising that focused on the banks relationships with its customers.
This certainly isn’t as easy a decision as it might appear, Bonnie noted.
You can say that again! Kelly responded. Ill just have to ponder all this information and decide what to recommend. Thanks for your help.
Questions for Discussion
Question 1. What type of new- product pricing strategy would be involved in considering a new free- checking product for the bank?
Question 2. What types of product mix pricing considerations do you see in banks pricing for checking accounts?
Question 3. What types of price- adjustment considerations do you see in the pricing strategies for checking accounts?
Question 4. What strategy would your recommend that Southeast Bank pursue on the free-checking account issue? What options does it have? How can break- even analysis (presented in Chapter 10) assist you in your analysis of the various options?
Sources: Officials at Southeast Bank cooperated in development of this case. See also: Tim Henderson, More ATM Fees, Free Checking, American Banker, June 17, 2002, p. 24; Laura Bruce, Checking Accounts Keep Climbing in Price, Bankrate. com, posted September 28, 2001.