A Payments Approach to Checking Services and Pricing
Revenues are growing significantly for consumer transaction account services, just not at financial institutions. Our research of FDIC data shows service charges on deposits fell nearly 20% between 2008 and 2012.
PayPal, on the other hand, grew revenues over 20% every year during the same time period. In 2013, they serve two-thirds of all households and generate revenues of $6 billion, one-fifth of the total service charge revenue reported by the FDIC for financial institutions. BillFloat generated 700,000 users from a standing start in 2009. Walmart and American Express are providing a “checking alternative” with Bluebird and 10% of debit purchases now occur with checking alternatives like reloadable prepaid cards, the fastest growing consumer finance segment.
Unlike financial institutions, which think in terms of transactions bundled into “accounts,” payments providers with growing revenues think in terms of segmenting individual transactions according to their specific use, context and experience. It is this “payments” approach to segmenting and pricing that is winning relationships and generating fees willingly paid by consumers.
If financial institutions want to grow checking revenue and relationships, they would be well served to adopt a similar payments approach to demand deposit account (DDA) services and pricing. This requires a change in the DDA revenue paradigm for financial institutions and execution of new payment services that are marketed not as part of existing “accounts” but as payment features that can be added to any account.
Bottom of the Pack
The current DDA revenue paradigm results from a history of providing and pricing accounts. Historically, the account’s value came from enabling and organizing transactions to store cash, process checks and to facilitate payments in-person or through the mail.
Today, a myriad of ways exist to transact beyond cash or checks, such as debit, prepaid, decoupled debit, credit card, gift cards, ACH, Bitcoin, PayPal, Dwolla, virtual wallets and cell phones. Venues to transact have also expanded from in-person or the mail to online and mobile technology. The ability to organize, view and store transactions has also exploded through online or mobile payment tools and through account aggregation.
Accounts still provide settlement, but their value in the hierarchy of payment methods, payment venues and payment management has fallen to the bottom of the pack. What creates value today is service for specific payment methods in context with a venue and related information.
A useful comparison can be made with the change in marketing music. Music used to be purchased and stored as packages of songs on CDs. However, most music today is acquired and organized as individual songs, with mobile and internet technology enabling high levels of flexibility for users.
Similarly, the shift in value for DDAs is to individual transactions managed and organized as the user might choose. The paradigm of marketing transactions packaged as accounts and sold in branches is going the same way as marketing record albums as packages of songs and sold in record stores. Efforts at reviving checking revenue by adding identity theft and assessing fees with minimum use are re-pricing buggy whips in a world of automobiles.
The new paradigm requires segmentation around individual payments use, context and experience rather than account types or user demographics. Where accounts can be thought of as a vertical analysis of all activities that fall under the account, payments providers think horizontally about the context of what happens before or after the payment. BillFloat, for example, links borrowing to a specific payment while Manilla manages the information related to specific past or upcoming payments.
Segmentation by use, context and experience changes the value of a generic transaction service just it affects the generic value of any product. Coffee, for example, purchased for $1 at a convenience store on the way to work is a different use, context and experience of the product than going to Starbucks with your laptop for a $5 latte. Popcorn offered for free in a car dealer showroom is a different use, context and experience than paying $7 for popcorn in a movie theatre.
Such horizontal segmentation opportunities for payments and related revenue abound. Horizontal differences exist among transactions for shopping online, giving money to your teenager for prom night, managing your budget while Christmas shopping, paying a large bill five days before you get paid, giving money to a baby sitter, paying a bill on your cell phone or writing a check for your mortgage. Under the new payments segmentation paradigm, accounts can be kept as simple as possible because it is not the account that differentiates the service; it is how the account can be customized with added payment services for the specific uses and context that differentiates the service.
While such a paradigm shift may seem daunting, robust revenue opportunities exist immediately for banks with three simple strategies: the companion payment card; the no-overdraft fee payment account; simplified, low-cost and automated liquidity services for DDA payments.
Companion Payment Card. This a checking account that is configured with reloadable prepaid card features. We estimate that financial institution customers will pay nearly $4 billion for prepaid card services to others this year, more than 10% of the total industry’s service charges on deposits. The vast majority of these cards are used by those with checking accounts as a companion card to load for certain transactions.
Many large financial institutions have implemented prepaid card strategies they underwrite themselves. Financial institutions under $10 billion, however, often look to a prepaid vendor that takes most of the prepaid revenue. Such financial institutions should configure a checking account as the consumer’s best alternative for prepaid, market it as a companion payment method and keep all fees and exempt interchange revenue for themselves.
The No-Overdraft Fee Payment Account. By far the largest reason consumers report they like a prepaid card is that it leaves them with no risk of incurring overdraft or insufficient funds fees. A key segment would like this feature with a full service checking account, even avoiding return check charges, and are willing to pay for it. Others such as Bluebird allow check writing with no insufficient funds or return check fees ever. By offering such an account, financial institutions can earn revenue and mitigate regulatory concerns. Such an account is a return-all account and does not cannibalize existing overdraft revenues, as users of overdraft services want accounts where items will be paid whenever possible.
Payment Liquidity Services. The largest opportunity for financial institutions today is to offer affordable, automated small dollar loans. Our research shows existing financial institution customers today pay more to non-financial institution competitors for small dollar loans than financial institutions earn in overdraft fees, and are a distinct market segment from overdraft users. Current lines of credit are cumbersome and limited by credit underwriting. Financial institutions can offer better, fairly priced small dollar lines of credit to consumers at low annual percentage yields, unlike payday and advance lending, and win these revenues back from their existing customers with automated operations and deposit-based underwriting.
Revenues are growing for transactions services and many further growth opportunities exist. Whether service charge revenues grow at financial institutions will depend on the extent to which they embrace a payments approach to DDA revenue.