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Fee Changes Require New Approach To Serving Mass Market

It appears that the steady unwinding of retail banking fees will continue to take its toll on bank and credit union profitability. Proposed regulations from the Consumer Financial Protection Bureau affecting overdrafts, non-sufficient funds, late fees and interchange are but the latest development in a trend many years in the making.

Curinos analysis indicates that, by 2025, overdraft (OD) and non-sufficient funds (NSF) fee revenue will be 80% lower than 2019 levels — for OD, this comes after a 57% drop in the prior decade. We also estimate that credit card late fees and interchange fees will be down 65% and 15%, respectively, in the same five-year period despite a resurgence during the pandemic (Figure 1).

Figure 1: Forecasted Impact Of Proposed Fee Cuts

Regulatory and competitive pressures are taking more fee income out of the system, making mass market relationships less profitable.
Forecasted Impact Of Proposed Fee Cuts

Note: 1Regulated depositories filing FFIEC 031/041/051 reports with greater than $1B in assets | 2OD/NSF charges on deposit accounts; reflects CFPB’s Jan 17th, 2024 changes to Reg E/Reg Z and assumes new cap on fees at $7 affecting depositories with over $10B in assets | 3Reflects the CFPB’s 2023 Q1 proposal to reduce late fee cap from an industry average of $30 to $8; reflecting an overall 73% decrease in revenue from late fees | 4Reflects Federal Reserve 2023 Q4 proposal to adjust debit/credit card interchange fee structures
Source: Curinos Analysis, S&P Global CapIQ, FFIEC Call Reports 031/041/051 (2019-2023), CFPB, Federal Reserve

These fees are derived disproportionately from the mass market, and while in decline, they continue to represent a significant portion of the segment’s revenue. Given the CFPB’s proposed actions, many in the industry are questioning the viability of serving a segment with limited value from a margin standpoint.

Challenges could be especially acute for community banks and credit unions, for which fees have traditionally accounted for a larger proportion of net income (6%) than for banks with $10 to $100 billion in assets (3%) and banks with more than $100 billion (2%). That gap is narrowing, so a key question becomes whether the proposed exemption of fee regulation for FIs below $10 billion will insulate them. Will it allow them to maintain an advantage on margins? After all, free checking with opaque back-end fees tends to sell better than charging for checking upfront. Or will these FIs need to bend to competitive pressures brought on by the changes affecting their larger rivals?

Another issue is fragmentation. Moving money around has gotten a lot easier, making it that much harder to maintain low-beta deposits. Five years ago, 1.7 checking relationships per customer was the norm. Today it’s more than 2.5 relationships (Figure 2). If a customer can avoid fees altogether by favoring or even switching to one of their other accounts, why wouldn’t they?

Figure 2: Average Number Of Checking Accounts

Customers are increasingly fragmenting their financials beyond their primary bank via relationships with other providers.

Source: Curinos Customer Knowledge | 2018-2023 U.S. Shopper Survey | Q8: At which of the following institutions do you keep a personal checking account? 

Strategies For Filling The Fee-Revenue Gap

As a result of these latest proposed regulatory actions, Curinos believes that a near-term hit to profitability is unavoidable for financial institutions heavily reliant on the mass market. This will be especially true for those that haven’t tended to the difficult work of optimizing their branch networks. But we also believe fees don’t have to underpin success serving mass market customers and members, nor do most institutions need to depend on them as much in the future.

Here are several strategies that could help fill the upcoming revenue gap left by the diminution of fees:

Embrace the true value of the mass market. The fees now under scrutiny have been designed to discourage certain customer/member behaviors. They were never intended to be a profit center for any segment. The true value of attracting and serving the mass market is access to low-cost deposits, and this is where branch banking has an advantage. Despite growing digital competition, mass market consumers continue to open accounts in branches and frequent them disproportionately. These balances can be modest, but they’re also relatively cheap. The portfolio rate for balances at or below $1,000 is currently about 23 basis points, compared with the 450 bp that many fintechs need to offer to attract switchers. The low interest expense can be a manageable fraction of the cost of maintaining the relationship. With technology driving down maintenance costs, institutions able to push enough customers toward digital engagement (e.g., fee for paper statements) can create a critical mass of profitability.

Give them protection they’re willing to pay for. Curinos research shows that retail customers/members in all market segments are willing to pay for overdraft protection. In our recent study of fees, we found that more than 60% of overdrafts come from consumers who say they meant to use the service. More than 80% of overdraft transactions come from consumers who opted into debit card with overdraft protection to cover their payments when necessary, and two-thirds of consumers say they plan to keep using the service despite the expense. It’s clear that there’s demand even if regulatory guidance is still formative. As OD/NSF fees shrink, providing protection through lines of credit, for example (with interest charges or flat fees) is likely to be a revenue opportunity for banks and credit unions.

Make more room for small business. Consistently, over time, we see that small-business deposits have a lower cost of funds than both consumer and commercial banking. A primary reason is that the majority of small businesses hold their balances in non-interest-bearing (NIB) checking accounts. Three years after opening, small-business accounts balances are on average three times greater than consumer balances. And when an FI has the primary lending relationship, it gets even better: Deposit balances with lending are more than twice as high as without.

Apply AI-driven personalization to acquire and retain. Within the mass market segment, the profiles and behaviors of customers and members diverge widely. Onboarding remains challenging for institutions, with most digitally originated customers (and about a quarter of branch-originated accounts) attriting within the first year. How does an institution fully onboard a new relationship, become their primary transaction account and get balances consolidated? On the rate-based deposit side, how does an institution identify and target, for example, a loyal “engaged saver” versus a less reliable “situational shopper”? This is where AI comes in. Amid the nearly limitless permutations of offers, messages and touches that can be presented, AI via a machine-learning platform can determine who to touch, what offers to make and the cadence required to elicit favorable action, all in near-real time (Figure 3). Its ability to adapt marketing experiences and effectiveness to each recipient is sharpened by continuous learning. With AI, there is never an “ideal” path — only what’s ideal for each individual. (See accompanying article in this issue of Curinos Review: “On A High-Rate Plateau, Getting Personal Is Key To Getting Deposits.”)

Figure 3: Pathways To Primacy

The journey to establish primacy with a new-to-bank customer is anything but linear.
Source: Curinos research

Financial institutions, consumer advocates and policymakers have a decades-long history of trying to balance consumer needs, financial wellbeing and program transparency with the cost (both reputational and financial) of providing programs that are both effective and sought after in the marketplace. In response to changes, the pendulum typically swings toward other revenue-enhancing services.

But one thing is clear: For most institutions, the mass market is too big and too valuable to ignore, so finding ways to make it acceptably profitable in a down cycle of fee generation should be among the highest near-term priorities for banks and credit unions.

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