Community banks that aggressively go after fee-based services rather than cutting costs to make money might be missing the boat, according to a University of Minnesota study.
"For us it was a bit surprising that small banks weren't participating in the benefits" of fee-income growth, said Glenn Pederson, a professor of applied economics and one of the study's authors, in an interview. "A lot of small banks are trying to use (fee-income generators) as a strategy."
But the study found that small banks that concentrate on controlling costs are more profitable than those that focus on fee-based services. Surprisingly, the analysis showed that small banks that pursued trust and insurance services were worse off for it.
In "Performance of Minnesota Banks: An Analysis of Strategic Management Choices," released last month, Mr. Pederson and Jeffrey Stensland studied call report and survey data from 112 Minnesota banks with average assets of $46.7 million.
They studied management strategies' impact on performance between 1988 and 1994, using a model that linked a bank's relative performance to its income sources over a seven-year period.
"There is no evidence that offering more services (has) a positive effect on bank profits," the authors wrote. "Although the results are not strong, the model suggests that insurance and trust services actually reduced bank profitability."
Evaluating returns on equity and assets, the study concluded, "Bankers who . . . pushed most rapidly into fee-generating services have tended to end up on the lower half of the performance charts."
The message to community banks, Mr. Pederson said, is "When they embark on a strategy like that, they have to be prepared to evaluate it on a regular basis," and change or discontinue it if necessary, which doesn't always happen.
The study categorized banks as high-, middle-, or low-performing, based on how ROA and ROE compared with state averages.
For the period studied, all Minnesota banks averaged 0.96% ROA and 10.7% ROE.
The study confirmed that some fee-income strategies, such as automated teller machines and telephone banking systems, helped improve profitability at small banks.
For instance, 73% of the high-performing banks with less than $50 million in assets had ATM machines, while only 37% of low-performers did.
However, in general, banks have had difficulty aggressively increasing noninterest income without also raising noninterest expense, the study said.
At banks surveyed, 76% of the smallest lower-performing banks operated insurance agencies, while only half of the higher-performing banks did.
As an alternate profit strategy, banks could focus on containing personnel expenses, the study said.
For banks under $50 million, slightly less than 4% of the highest performing banks had officer salary increases in 1994.
