Luring Deposits

By Bill Stoneman

While financial institutions can employ many strategies to gather deposits, success depends on a long-term commitment to that business.

After years of neglect, deposits are suddenly back in vogue in the banking industry. Banks all across the country have launched aggressive campaigns to boost their "core" deposits, which consist of checking and savings accounts. But a debate is brewing over the question of how best to go about it.

The product that has captured the most attention in these campaigns is "free" checking, or an account not requiring a monthly fee. Based on the publicity free checking has generated, one might be tempted to conclude this product is a panacea for all of an institution's deposit-gathering needs. But experts say otherwise.

While free checking can indeed help generate a favorable marketing buzz, sound deposit-acquisition campaigns employ a plethora of other strategies, such as improved service, extended hours, new branches and targeted marketing. Account retention — usually a function of steady, reliable service over time — plays an equally important role. "Along with attracting a lot of accounts, you also have to focus on retention and service," says Jim Barri, executive vice president and head of retail banking at Compass Bancshares Inc., Birmingham, Ala.

A recent study by BAI and First Manhattan Consulting Group documented how spreads from core deposits provide 40% of the revenues and almost two-thirds of the profits associated with managing consumer assets. The problem, for banks, is that they have been losing market share of those assets, from 16% of a $12 trillion pie in 1993 to 9% of a $23 trillion market in 1999. Many of the funds once held in checking and savings accounts migrated to investment products and money market mutual funds during this period.

To be sure, some of that money is now returning. In the wake of the nearly two year-old stock market swoon, customers are fleeing to the safety of federally-insured accounts. The Federal Deposit Insurance Corp. recently reported that deposit growth outpaced loan growth for four consecutive quarters, beginning with 2000's last quarter. Yet bankers cannot count on this shift being permanent. For that reason, a continuing focus on deposit strategy is essential to provide institutions with a stable base of low-cost deposits. Such long-term perseverance will achieve far more than sporadically tapping the funds market with short-term promotions.

"There really is no secret sauce," says William J. Black, managing director of Second Curve Capital, a New York City-based hedge fund investing in financial services stocks. Consistent deposit acquisition "begins with managers who understand that core deposits are inherently, enormously profitable."

Loss Leader?

For now, free checking is unquestionably the fashionable strategy for acquiring consumer deposits. The tactic is used by institutions across the country, including Seattle-based Washington Mutual Inc.; TCF Financial Corp., Minneapolis; Fifth Third Bancorp in Cincinnati; and Charter One Financial Corp., Cleveland.

The appeal is powerful for price-conscious consumers. Why pay a monthly fee if you don't have to?

The calculation for banks is more complex. They do, after all, incur a cost to acquire and then maintain these accounts, so the loss of revenue must be made up somewhere else, usually with other fees. Alternatively, the product can be tolerated as a "loss leader" if it brings in other business. "The key to truly free checking is figuring out how you're going to make money on the account after waiving the monthly service charge," says Gordon Goetzmann, a vice president at First Manhattan.

TCF, an $11.7 billion-asset thrift, tries to replace the lost fee income. During a presentation to investors last November, the company said it generates $208 in fees annually per checking account. CEO William Cooper says these revenues primarily stem from overdraft fees, and also from client usage of non-proprietary automated teller machines and fractions of each transaction rebated by merchants on debit card payments.

Clearly, some banks are willing to tolerate thin margins on free checking accounts as long as customers occasionally purchase additional products or generate a modicum of bounced-check and debit card fees. But for others, the real value in free checking is that the word "free" looks good on banners hung outside of branches.

The game plan at these institutions is to start explaining the benefits of an interest-paying (and fee-based) account as soon as prospects come in the door. At Charter One, for example, a significant number of people attracted by the free checking promotion end up in accounts with fees, according to Mark Grossi, executive vice president and head of retail at the $37 billion-asset thrift.

While such an approach may seem a bit like "bait-and-switch," it's actually a form of segmented marketing. Free checking promotions are typically directed at the mass market — cost-conscious people who don't carry high balances. These small-balance accounts may not, in the aggregate, actually add up to much.

In fact, a recent survey by Capital Performance Group found that institutions aggressively marketing free checking actually lagged other institutions in growing total deposits. In a study that ranged between June 1999 and June 2000, institutions offering free checking did succeed in growing demand deposits by 2% even as their rivals recorded a 2% decline. But the banks eschewing free accounts posted the highest growth in total deposits — 4%, versus only 1% for the free checking crowd.

Gary D. Stein, a partner in the Washington, D.C.-based consulting firm, says banks need to buttress their free-checking promotions with programs to attract long-term money, i.e., funds held for savings. This requires accounts that pay interest on those funds. Although high-balance customers may be initially attracted by a free-checking promotion, the institution can often help itself and the customers by steering them toward interest-bearing products that also provide a monthly fee for the bank.

For Charter One and Fifth Third, acquiring these interest-bearing checking accounts is at least as important as free-checking promotions in their overall deposit strategy. Both institutions offer rates on these accounts that are below those paid by money market mutual funds but well above those of competing banks.

And they say moving toward money market rates on large balances is essential, both to retain the dwindling pool of high-balance customers, and to reclaim others from brokerage and mutual fund accounts. "You can't confuse the market and say, 'I'm offering an interest-bearing checking account, here's 1%,'" says Wil Daly, Fifth Third's chief marketing officer.

With 22% growth in demand deposit balances from the third quarter of 2000 to the third quarter of 2001 and 23% growth in interest-bearing checking account balances during the same period, the $70 billion-asset Fifth Third is setting a pace that few others can match. Such growth allows Fifth Third to be less competitive in its certificate of deposit promotions. By replacing CD balances with checking balances, even those paying near money market rates, the company actually reduces the average interest rate paid on deposits, according to Daly.

Free checking and checking with high interest rates, however, are just part of a successful deposit strategy, Daly adds. Other factors on his list include a good branch network, an aggressive sales culture and competitive products.

Fifth Third's sales culture is particularly aggressive. Regional executives are under heavy pressure to meet ambitious deposit sales goals, so they set demanding targets for branch managers. The regional executives then get weekly reports showing exactly how they're faring compared with one another. And George A. Schaefer Jr., the company's president and CEO, isn't shy about commenting on their performance, according to Daly. "George will send a little note out saying, 'Is this really the best you can do?'"

Convenience Sells

Given the drawbacks of free checking, institutions have little incentive to offer the product unless they are pursuing mass-market business. But that doesn't mean these banks can't attract deposits. Long Island's North Fork Bancorp Inc., for example, gets most of its funds from small-business customers.

Carolyn Drexel, executive vice president and head of retail at North Fork, says the $16 billion-asset institution has been opportunistic in courting small businesses, which often keep high balances on deposit. The bank has leveraged former thrift branches that it acquired by bringing commercial services to them for the first time.

It has even moved into Manhattan, where the dominant banks focus on large corporate and mass consumer business. North Fork acquired one branch in New York City in the mid-1990s and then opened eight more de novo offices there over the next several years. The purchase of Commercial Bank of New York brought 11 more offices last November.

North Fork depends on its branch managers, private bankers and other branch-based relationship officers to drum up business by networking with business owners and referral sources. Rather than pitching the best price in town, these officers emphasize responsiveness and service.

New relationships are as likely to start with loans as deposits, Drexel adds. "If we're going to approve a loan we're going to ask for the full banking relationship." By mid-year 2001, North Fork had posted five-year compound annual growth of 35% in demand deposits and 29% in total deposit balances.

Unlike North Fork, TCF is interested in the mass market and does offer free checking. As at North Fork, however, branch expansion plays a prominent role in its deposit strategy. From the beginning of 1999 through August 2001, the thrift opened 79 branches, including 74 in supermarkets, and all of them are open 12 hours a day, seven days a week. CEO Cooper says such convenience outweighs everything else in two-career households when consumers decide where to do their banking. "Every holiday, I open more new accounts than on any other day of the year," he says.

Total deposits at TCF rose a modest 3% in the 12-month period ended Sept. 30, 2001. But that total reflects a 7.8% decline in time deposit balances, and a shift to more profitable checking and money-market accounts.

Long hours and de novo branches are likewise behind extraordinary deposit growth at Cherry Hill, N.J.-based Commerce Bancorp. Total deposits grew 33% from the third quarter of 2000 to the third quarter of 2001 at the $10.4 billion-asset institution.

While the bank does offer a near-free checking account — one that requires a balance of $100 after the first year to avoid a monthly fee — Commerce doesn't put this product front and center in its marketing campaign. "It's more of a low-hassle service offer at Commerce, as opposed to a best-deal-in-the-market offer," says Capital Performance's Stein.

Service Strategy

Techniques for account acquisition may get all the attention, but account retention is just as important an issue for retail bankers. Institutions can always go into the market and raise funds on a short-term basis, usually with rate promotions. But the real key to maintaining a stable deposit base is keeping those accounts for a prolonged period of time.

For most institutions, this comes down to an issue of service — the day-in, day-out process of keeping customers satisfied. "It's about a relationship," says Sherief Meleis, a director with Novantas, a New York City-based consulting firm. "It's about people down at the branch who know my business."

The benefits of good service include stemming attrition and attracting larger deposit balances as customers consolidate their business, which can pave the way for cross-selling additional products, says Compass Bancshares' Barri.

Compass, which has $22 billion of assets, began a serious effort to upgrade service about two years ago. "Mystery shoppers" now visit and telephone branches. Additionally, the bank mails questionnaires to customers, asking them for information about recent experiences. Barri says this initiative has slowed customer turnover and increased the proportion of multi-product customers.

Other banks have reached a similar conclusion as Compass — that satisfied customers account for deposit growth as much as showy sales promotions. Beverly Hills, Calif.-based City National Corp., for example, has racked up a 19% compound annual deposit growth over a five-year period extending through mid-2001.

Its secret? Offering private and small-business banking services in a more personalized context than its competitors, according to George H. Benter Jr., president and chief operating officer of the $10 billion-asset institution. "A lot of people come to us," Benter says, "because they are frustrated at other banks that they can't find someone to deal with face to face."

As the examples of TCF, North Fork, Commerce and City National seem to suggest, small may be better when it comes to deposit generation. While banks across the spectrum have struggled with lackluster deposit growth, it's particularly difficult to find large banks that have shown significant internal deposit growth. The picture, however, is somewhat brighter at mid-sized banks and still more positive at small banks, according to statistics compiled by Novantas.

Since small banks typically don't have strong sales cultures, Meleis says, the most likely explanation is that smaller institutions do a better job of retaining established customers, who in turn bring in more business over time. Larger banks, by contrast, tend to alienate their customers with indifferent service and excessive fees. Even though the large banks can't become small," Meleis says, "they need to recreate the small-bank feeling."

Mr. Stoneman is a freelance writer based in Albany, N.Y.

Copyright © 2003 by Banking Strategies, published by BAI.

back to top