By now it is pretty well established that community banks profits depend on curbing noncredit expenses and boosting noncredit income.
In the good old days a banker could obtain funds at 3%, lend them out at 6%, and be on the golf course by 3 p.m. But volatile interest rates have made this policy dangerous. If CD rates soar while the bank is stuck with fixed-rate mortgages at 6%, then 3, 6, and 3 becomes 9, 6, and who knows when I will get out of here.
Most banks are controlling expenses the best they can. A sound efficiency ratio has become as important as earnings per share or return on assets. As for generating noncredit income, improvements have been somewhat slower, but there are opportunities out there.
Take the retirement plan business. Only a small percentage of smaller businesses have developed 401(k) programs, leaving ample opportunities for banks to develop and run such programs for these businesses. The potential payoff for the bank is increased fees and additional deposits.
Relationships with mortgage companies, insurance agencies, and smaller brokerage firms also can bring in extra fee income.
Of course, many observers say service charges are the most sensible way to add fee income, but that can be carried to ridiculous levels.
In a recent newsletter put out by Cross Keys Bank of St. Joseph, La., the columnist/author Bob Greene talks about how Bank One Corp. charges some customers a fee for using a teller. I would think that customers would prefer to go to a bank that values its business and shows its appreciation by allowing them to speak with tellers for free, he says.
On the other hand, overdrawn accounts are a valid fee source. Banks that impose fees on overdrafts say this is a crucial source of income. They are amazed that many competitors simply waive these fees month after month and routinely let customers bounce checks without penalty.
Why? Evidently the people authorized to waive the fees feel it generates goodwill for the bank. However, few customers complain when they are assessed fees for overdrafts. It seems they know what they are doing, and that they should pay. Also, many banks that waive these charges report that a substantial percentage of their overdrawn accounts are unprofitable in the first place.
In addition to deciding whether to collect fees on overdrafts, banks must examine their policy of whether to handle incoming checks in the order of arrival, honor the smallest ones first, or honor the largest first. Naturally, the third choice can run the risk of using up the good funds in an account and throwing several smaller checks into overdraft.
Some banks honor the largest checks first because they feel these checks are probably the most important to the depositor. Others clear the smallest first, in order to bounce the fewest checks possible. And some community bankers call the customers and ask in what order they want the checks handled.
Bottom line: Banks need fee income, and charging overdraft fees to customers who do not follow the rules is a fair way to generate it. If a community bank feels this is unfriendly, it should not have an overdraft policy to begin with.
Mr. Nadler, an American Banker contributing editor, is a professor of finance at Rutgers University Graduate School of Management in Newark, N.J.
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