Want to improve customer retention and boost revenue at the same time? “Offer customers overdraft protection” is the recommendation of Gordon Goetzmann, an executive vice president at First Manhattan Consulting Group.

“Banks can markedly raise retention rates when they offer overdraft protection,” Goetzmann said. “There is always a concern that the bank will forgo a lot of near–term income. But the reality is, people overdraft more and they stick around.”

Goetzmann made his remarks on February 24 at the BAI TransPay Conference & Expo in San Diego, Calif. Speaking on the topic of “Revitalizing DDA Profitability,” he noted that banks do lose money in the short term by offering overdraft protection because they earn less from non–sufficient funds (NSF) charges.

But Goetzmann asserted that offering balance alerts, advances on paychecks, protection links to savings accounts and credit counseling would help banks build customer loyalty and more than make up the difference in lost NSF income. He cited research showing that banks that aggressively charge for overdrafts have demonstrated relatively poor growth rates.

For example, the most aggressive one, charging 20% had an annual deposit growth rate of 1% from 2001 to 2007, according to a First Manhattan study of 70 regional banks. That compares with a 6% growth rate for the 20% least aggressive fee chargers, Goetzmann said.

He conceded that overdraft fees may be hard to give up, especially since they occur across the customer base regardless of account size. About 40% of customers with balances of $500 or less incur an overdraft an average of 13 times a year. Similarly, 45% of customers with balances of $500 to $1,000 do so, also at an average rate of 13 times annually. And 9% of those with balances greater than $10,000 do so at a clip of nine times a year.

Goetzman asserted that what banks gain in fee income — customers running average balances less than $500 represent 30% to 45% of all account holders, averaging $175 in fees a year — is lost in higher attrition rates. He pointed out that even with overdraft protection, a bank can still count on some customers exceeding their credit line. For example, customers with average balances of $500 or less surpass their credit lines an average of 7.2 times a year, vs. only 5.1 times for those without overdraft protection.

Yet customer loyalty is not compromised in these situations since the bank had extended credit in the first place, according to Goetzmann. Customers in that position tend to accept the bank's policy as fair play, he said.

Goetzmann added that banks can build loyalty by better understanding their customers most likely to overdraft. Seventy percent of the average bank–s customers have a balance of $2,500 or less, representing about 10% of all deposits. Yet this group, according to Goetzmann, includes three distinct segments: uninformed, impulsive spenders; those who live paycheck to paycheck; and a third group of “informed, diligent savers.”

For the impulsive spenders, a bank could differentiate itself by offering advance alerts, payday advance products tied to direct deposit and credit counseling. Diligent savers, meanwhile, could be offered extra overdraft protection, the ability to use savings balances to cover overdrafts and flat fees to avoid surprises, Goetzmann said.

(For more on overdraft and non–sufficient funds issues, see “Sweeping Away Free Checking?” in the January/February 2009 issue of BAI Banking Strategies and “Framing Payments Strategy around the Checking Account” in the January/February 2008 issue. Also, see “Overdraft Yes, but Not Too Much” in the February 13, 2007 issue of BAI Banking Strategies Retail Delivery Insights.)

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