There is a new debate emerging among policymakers in advanced economies. Two Federal Reserve Bank chief executives have taken the position that the natural rate of interest in the United States is much lower than previously assumed. These experts suggest the need for a slow pace of increases in short-term rates, with one Fed president projecting only one 25 basis point increase between now and 2019, and the other suggesting negative rates are increasingly possible in the next economic downturn.
Recently, U.K. gilts briefly joined the growing number of sovereign bonds that trade at negative yields. Investors should take note. Capital flows from regions of the world with slow growth and negative rates will continue to exert downward pressure on the term structure of the U.S. interest rates. As I have said before, it would be imprudent for investors to rule out the possibility of negative rates in the United States.

A Low Natural Rate is Prompting Policy Makers to Rethink Existing Frameworks

The natural rate of interest is the real federal funds target rate that would be neither expansionary nor contractionary if the economy were operating near its potential. A model estimate of the natural rate—developed by Thomas Laubach and John Williams, currently President of the San Francisco Fed—has fallen sharply since the crisis and stands only slightly above zero. A lower natural rate implies less need for policy to tighten and a greater likelihood that policy measures now considered unconventional will be employed in future cycles.

When was the last time your institution made a significant change to its account lineup? If you’re like many in the industry, it’s probably been awhile.  

There’s something to be said, of course, for keeping things consistent for your customers, which can certainly be accomplished by maintaining the same account structure you’ve offered for the past several decades. But with mounting costs, increased competition and ever-tightening margins, the question becomes whether you can afford to hold onto that type of consistency.

One way to evolve an account lineup – and generate new income in the process – is to begin charging fees on accounts that were previously free. It may sound like the kind of innovation that will only succeed in chasing off fee-adverse customers – especially when there are so many other options from which to choose – but R. Scott Richardson, the president and CEO of IZALE Financial Group, believes that the right kinds of fee-based accounts can be beneficial for both institutions and customers alike.      

The Update caught up with Richardson to get his thoughts on how moving from free to fee can help community institutions evolve their account lineups.    

FMS Update:  What are some of the reasons an institution might think about tweaking its account lineup and introducing fees?

R. Scott Richardson:  First off, you have to look at some of the regulatory changes that have come along, such as Reg E, which has the potential to impact an institution’s interchange fee income. So banks are looking for opportunities to maintain the income they had or to possibly generate new income.

In addition, a lot of institutions just have stale accounts. In many cases, it’s been awhile since they’ve done much with them, so now there’s an opportunity to look at what they have and rethink that lineup.

FMS Update:  The general thinking is that institutions like the idea of fee income, but customers hate fees. How can an institution successfully make the switch to a fee-based account, especially if customers are used to getting things for free?

Richardson:  The industry did a remarkable job of communicating the notion that free was good when they started introducing these accounts. But the simple truth is that these accounts have never been free to the institution – they’re the products of a bygone era of higher interest rates and higher margins, when institutions could absorb those costs as loss leaders.

So the first step is really to underscore the value of what the account is in the first place. If you want to have a free account, then tone it down – make it a basic, bare-bones account without any big bells and whistles, and that will be what people perceive the value to be. It’s like buying a car. If you want a Lexus with all of the fancy bells and whistles, that’s fine; but a Toyota, made by the same manufacturer, will still get you there – it’s just going to be a different kind of ride.

FMS Update:  What type of value-add services are customers willing to pay for?

Richardson:  One thing is identity theft solutions, because customers clearly understand just how big of a problem it is. Time and again, customers have said they want identity theft alerts – some kind of indication when someone is pinging the credit bureaus with information that isn’t theirs. This can also include fraud recovery services and fraud-related expense reimbursements.

Another value offering is credit score monitoring, with a triple bureau check and dynamic scoring. People think that credit scores are only related to getting a loan, but the more you educate them about how important it can be for auto insurance and life insurance and getting a job or an apartment, the more they realize what a key component it is for their whole financial life. This is an opportunity to educate your customers, giving them an idea of the one or two things that might be dragging their score down and offering ideas as to how they might be able to fix those things.

Finally, there’s potential value to be had in local couponing. This one can work for the institution on two fronts – to drive your customers to that local business, and perhaps to drive that local business back to your bank or credit union for a commercial relationship.

FMS Update:  What are some of the common mistakes institutions make when trying to expand their offerings to add fee-based accounts?   

Richardson:  Training is probably the most important thing. A lack of training and a failure to get the staff excited about the change is a common mistake. Institutions should be giving the fee account away to their employees first – let them use it, encourage them to use it. This way when you start to roll it out to customers, the employees can speak from first-hand experience. “Here’s the value that I’m getting from this account – have you tried this?”

Another common mistake is not fully knowing your customers in the first place. Where are your accounts profitable or unprofitable? When you design the new account, you want to do it in such a way that your best customers are going to feel the least impact and your worst customers are going to feel the most, potentially changing their behaviors to become better customers.

One mistake would be to simply introduce a fee without providing any more value to the consumer.  If you introduce a fee, you have to provide new, relevant products and services to go along with it.

It’s really about taking a step back and determining what you’re trying to accomplish with the change in your accounts. In many cases, it’s going to be trying to encourage behaviors that result in you becoming or remaining their primary financial institution.

FMS Update:  How should institutions approach the pricing of a fee-based account?

Richardson:  Start with your own costs, because when you add services like identity theft alerts and credit scores, there’s obviously going to be a cost to the institution. The question then becomes how much above that do you want to go so that you can create the income opportunity you’re looking for? In most cases, it’s a matter of seeing what’s going on in your marketplace and understanding your customers a little bit better.

It’s also important to have an understanding of what you’re trying to accomplish. Are you looking to just create value within the account, or are you looking to create more of a relationship-type account? That is, you might charge a higher fee initially, but encourage behaviors that allow customers to reduce that fee each month. For instance, e-statement sign-up might knock a dollar off that fee, or more debit swipes or higher loan balances. All of those behaviors improve the institution in other ways, so the ability to reduce that fee and forgo the raw income from that account is offset by improvements elsewhere – twenty debit swipes results in more income than ten did, or having a loan balance above a certain amount gives the institution more interest income, and so on.

It’s really about taking a step back and determining what you’re trying to accomplish with the change in your accounts. In many cases, it’s going to be trying to encourage behaviors that result in you becoming or remaining their primary financial institution.      

FMS Update:  What are some of the keys to successfully introducing a new fee-based account?

Richardson:  This is a multi-pronged process, with three main components.

The first part is the training aspect, and this is an area where you don’t want to skimp. Give your staff enough time to get excited about what you’re offering and why you’re offering it. They should also be using it, so they can talk about it knowledgeably.

The second piece is having the right materials. There may be a lot of boring statutory stuff that has to go along with changing the terms of an account, but that’s not all you should be doing. You can also enclose marketing material – and update your website – to really stress the value and the features of the new account structure.

Lastly, and this really goes along with the training aspect, you need to make sure you have the patience to get through the first one to two months of initial responses from customers, because the most complaints and concerns will come within that opening period. Train your people to respond appropriately, and encourage your customers to try out the services before pulling the plug and going back to a different account. You have to have buy-in from both leadership and front line employees, otherwise implementation will be much more challenging.

FMS Update:  What would you say to an institution that sees the need for fee income but is too worried about alienating customers to pull the trigger on a fee-based account?

Richardson:  Twenty years ago when institutions were introducing free checking, everyone thought they were crazy, but now it’s the norm. But it’s not the norm because it’s profitable for the institution – it was a marketing gimmick to get consumers in the door and hopefully lead to a deeper banking relationship. This, on the other hand, is not a gimmick; you’re giving people real value for the fees that they’re going to pay. Whether they take advantage of that value every month is in their control – you can’t force them to do it. But you’re giving them the opportunity to get real value from that account, which is in multiples of what you’re actually charging them.

This is a path that thousands of institutions have taken. So don’t listen to a vendor on what the merits of the program might be – talk to your peers. Ask for a list of references in your area, and be prepared with very specific questions about what those institutions like yours have experienced. That will give you the best idea of the work and potential rewards that lie ahead of you.   

Has your institution recently moved from a free to fee account structure? Your fellow FMS members would love to hear about your experience on FMS Connect!