With fee income becoming a more significant portion of banks' income statements, focused noninterest income strategies are becoming increasingly critical. However, very few banks apply the level of scrutiny and sophistication to noninterest income sources that they do to loan and deposit income.
Over the next decade, winning banks will build customer value through a superior fee income approach.
Banks have dramatically increased their fee-based businesses. Noninterest income represented 43% of revenue for U.S. commercial banks by 1999, versus 40% in Australia, 33% in northern Europe, and 13% in Japan.
Wall Street has long applauded strategies for increasing noninterest income. Bank of New York has become an analysts' favorite on the strength of its continued noninterest income performance. In the third quarter 63% of its revenue came from noninterest income. The bank now commands a price/earnings ratio of approximately 30, roughly twice the industry average.
By 2005 nearly 60% of banks' revenue will probably come from noninterest sources. Yet several sources of concern threaten the future of noninterest growth.
Firstly, bank bashing has become a favorite pastime for the public and press, largely as a result of poorly guided and underdeveloped fee increase initiatives that have been badly communicated. Media stories range from the battle over ATM fees in Santa Monica, Calif., to disgruntled customers on both coasts debating inactivity fees, minimum balance requirements, account maintenance charges, and returned-check fees.
Secondly, customer backlash over noninterest income has also made its way to the courts and statehouses. From ATM surcharge fee struggles to the proposed "bank fee fairness measure" in Massachusetts, costly legal and regulatory battles are challenging banks' ability to boost noninterest income. Providian Financial Corp., Citigroup Inc., and Chase Manhattan Corp. were among the companies that settled class actions over card division fees last year.
Finally, there is emerging evidence that unsophisticated fee increases do not help revenue. A Federal Reserve study last year concluded that increased fees do not produce increased revenues when they are not linked to perceived customer value.
But opportunities abound for establishing sophisticated fee strategies.
Most banks have at best a broad understanding of what drives their noninterest income. Establishing the starting point for each line of business (after setting aside noncontrollable and nonrecurring items) is a key step that is often ignored.
Banks that don't have all the facts often base their fee changes on perceptions and a "match the bank across the street" methodology. However, the key to unlocking noninterest income potential lies in truly understanding a product's cost. One regional bank found that two of three deposit products were losing money and required a complete overhaul.
Product attribute rankings and customer value analysis help identify "pockets of value." A major Australian bank found that several attributes of its cornerstone commercial lending products were dramatically underpriced when compared with their value.
Elasticity analysis reveals evidence of pricing mistakes and opportunities alike. A Western regional bank found an opportunity to eliminate a particularly elastic fee, and as a result the bank gained the benefits of increased volume and improved public relations.
Fee waiver and exemption analysis typically finds that employee practices are in stark contrast with official policy. Noncollection rates for some fees have been found to be as high as 70%.
What's more, risk and runoff analysis enables product managers and business leaders to assess the likely competitive and customer reaction to any change.
This set of analyses paints a robust picture of reality and enables the bank to focus on growth opportunities.
Australian and European banks have found very significant fee sources yet untouched by the majority of U.S. banking institutions. At one Australian bank, loan administration fees on residential and noncard consumer loans represent as much as 80% of the consumer lending fees.
Similarly, as online banking programs mature in places like Scandinavia, new noninterest income opportunities such as transaction, account keeping, and opening and closing fees are created as well.
Lending and online banking sources will continue to grow in importance as the nature of these services continues to develop. The key for U.S. bankers is to keep their eyes and ears open, anticipate, and recognize these opportunities as they present themselves.
Most banks also tend not to actively monitor or track their fee initiatives.
One regional bank began reviewing proposed fee initiatives, but kept no record of the market reception, customer runoff, and behavior changes. As a result, the bank got no value from this process.
Another regional bank launched a series of fee increases in one division without recognizing the impact this would have on other divisions. This resulted in a net loss for the organization.
The benefit of monitoring and tracking is that what gets measured gets done. One regional bank formed a fee waiver task force that focused on tracking and reporting fee waivers. The result: Fee waivers went down more than 50%, and more than $5 million was added to the bank's bottom line.
As noninterest income approaches 50% of revenue, most banks are woefully underskilled in sophisticated fee pricing. Banks that assemble a meaningful fact base will be more likely to achieve their revenue targets. In most cases, this fact base can only be assembled through a dedicated review process or as part of more comprehensive changes.
Understanding the perceived customer value of products and services is not a trivial or easy task. Elasticity grids, regular market benchmarking, and evaluation of pricing initiatives are a few of the tools that are increasingly becoming best practice for the leaders in the industry.
And though the revenue management sophistication applied in other industries is a very remote target for most banks today, it will become industry practice over the next decade as the battle for customers' fees intensifies further.
Ms. Corbelli is president and Mr. Ryen a managing director of Aston Associates, a Greenwich, Conn., corporate reengineering firm.
