In the early '90s, free checking was a pretty good idea. It provided financial institutions with the opportunity to acquire customers who might one day become more profitable, with the typical checking account earning just over $12 per year, pretax. But even before the financial crisis, free checking was beginning to look like a questionable proposition. An analysis of Federal Deposit Insurance Corp. data shows that by the early 2000s, the typical checking account was losing almost $50 per year due to declining interest rates and rising expenses.

Rolling forward to today, free checking has become a truly terrible idea. The typical account now loses almost $200 per year, with low interest rates, higher costs and reduced fee income all taking a toll. Unfortunately for most community banks, little has been done to effectively reform what has become an outdated strategy.

Free checking has traditionally been subsidized in large part by overdraft and debit interchange fees. But these revenue sources shrunk dramatically due to regulatory and legislative changes since 2010. Worse yet, the historic decline in interest rates since 2008 has severely reduced the value of deposits. Since 2007, deposit fee income across the community banking industry as a percentage of average assets has declined from 0.34% to 0.26% last year—a 24% reduction! To put this fall-off in terms of dollars, community bank fees on deposit accounts have dropped by more than $1.5 billion over this period. Something clearly has to be done to reverse this trend.

Since free checking was introduced, there has been a radical transformation in the retail banking business. In the early '90s, we weren't providing services like online banking, automated bill pay or mobile banking. While all this technology has improved service to consumers, it's added substantial expense to checking products, with no corresponding increase in fee income, as most banks don't charge for these services.

The catastrophic effect on checking account profitability at the average community bank plays a major role in concentrating profitability at the top 5% to 10% of an institution's client base. Strunk has found the typical community bank generates 100% of the strategic value of its customer base via the top 7% of the client base. The second customer tier represents 19% of the customer base and produces 25% of strategic value. Unfortunately, things head downhill from there. The middle tier consists of 25% of customers but only drives 10% of value, and the bottom two tiers—almost 50% of customers—produce negative strategic value.

The solution to this problem is fairly simple, but proper execution is critical to success. As an industry, we can no longer afford to give away our outstanding services for nothing. We need to generate significant ongoing fees from the vast majority of our checking account customer base. Unfortunately, we've spent the last 20 years convincing consumers that free checking is a birthright that no one should pay for.

To execute a solution effectively, we need to implement a simple customer segmentation strategy and build a package of services that drives balance consolidation, increases fees and creates value for each segment.

Although we would like to drive strategic value by increasing balances, unfortunately, for the vast majority of customers, this simply won't be possible.

For approximately 80% of the industry's base, we need to implement a fee strategy, because it's the only avenue to achieving profitability with these customers. The trick here is to provide enhancements to the checking product that are in high demand by consumers—enhancements that we know consumers are willing to pay for. These extras, such as credit score monitoring, identity theft alerts and cell phone insurance, must be low cost to the bank, but high value to the consumer.

The industry is facing heightened regulatory pressure that is increasing the cost base and decreasing fee income. The interest rate environment and low-to-modest loan demand has squeezed margins, and higher capital requirements will create additional stress.

The time has come to diversify sources of fee income, and a large, and largely unprofitable, checking account base is a great place to start.


Roderick is the CEO of the consulting firm Strunk LLC. He is based in Atlanta.

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