The new overdraft regulation that takes effect July 1 will cost banks millions of dollars in lost revenue.
While banks scramble to get as many customers as possible to opt-in in compliance with the new regulations, most have not announced a broader change in overdraft policy.
Simply complying with a regulation is not enough to protect fee revenue. Banks need to know how these changes will affect performance and develop strategies to minimize losses.
Some, like Bank of America Corp. and JPMorgan Chase & Co., have already made sweeping changes in overdraft policy. While changing overdraft strategy is vital, their approach of modifying policy for all customers is not the best one.
Changing policy quickly and uniformly leaves no way to tell what the impact will be. The changes may significantly hurt profitability, and it will be very difficult to roll them back.
The many banks that have remained silent are smart not to take broad action. They should instead start testing different approaches to understand which work best.
Think clinical trials for business. The only way to determine how customers will actually respond to a change is to design a well-structured test imposing changes on some customers but not all, with a well-chosen control group for comparison.
The first step in this process is to brainstorm a list of strategies.
Each should then be implemented with a subset of test customers. These customers should be compared to a similar set of customers who retain business-as-usual overdraft policies. The difference in performance of the test and business-as-usual customers is measured across a set of key metrics like fee revenue, number of chargeoffs and customer satisfaction.
This scientific approach should be applied in two ways — testing overdraft policy changes that may be included in future regulation and trying new approaches to maximize revenue in a regulated environment.
For the first, many ways exist to modify overdraft policy that could be in the scope of future regulation — changing the maximum fee amount, capping the number of fees that can be assessed or allowing overdraft fees only when an account is overdrawn by more than a certain amount.
It is important to test strategies today to understand what works best.
The second type of testing should focus on ways to minimize losses from the changes that come July 1, and a variety of strategies could be employed.
For example, with less fee revenue, it will be difficult to continue offering universal free checking. One option is to adopt a monthly fee for some checking accounts, and the key will be determining the amount of the fee and which customer segments should be subject to it.
Another potential strategy is to reduce the overdraft limit for customers that are more likely to charge off. This would result in fewer fees, but the reduction in revenue may be offset by incurring fewer losses from chargeoffs.
These are just a few of the many strategies that could be used to minimize losses from the July regulation and potential future regulation.
There is no way to tell which strategy will work best, so it is important to start testing approaches immediately.
Different types of customers will also have widely varying responses to new policies.
Some may not react negatively to a monthly checking account fee, but the same policy could prompt others to switch banks. Such an increase in attrition would offset the benefit of additional fee revenue.
Testing to determine the right overdraft policy must be continual. The optimal overdraft approach will evolve as competitors modify their overdraft policies. Preserving fee revenue will undoubtedly be difficult in a more regulated environment.
But these challenges also provide an opportunity to beat your competition.
The banks that are able to quantify the impact of regulatory changes ahead of time, try different approaches to minimize losses, determine what works best and adjust policy accordingly will survive the regulatory overhaul and come out stronger.