The Federal Reserve has signaled that rising interest rates might be on the way, raising the risk that community banks’ margins will be squeezed in the future. Help is available, though, and it comes from a somewhat surprising source: high-yield, reward-based checking accounts.
While many banks use certificates of deposit (CDs) to mitigate rate increases, that’s a short-term solution to a long-term problem. Reward checking accounts, by contrast, provide a substantial cost of funds (COF) discount that steadily increases as interest rates rise. Additionally, these accounts work to foster closer, more profitable customer relationships and grow institutions’ core deposits.
When are rates going to rise? No one knows for sure, but it seems likely to happen soon. At its most recent meeting, the Federal Reserve announced that it was ending its bond-buying program, which has been keeping long-term rates low, and indicated that it might consider raising its benchmark short-term rate by mid-2015. Averaging the forecasts of members of the Federal Open Market Committee suggests that the federal funds rate could increase 1.13% in 2015, 2.5% in 2016 and 3.75% in the long run.
Whenever rates go up, financial institutions will see their interest costs rise and their margins compress. That’s where high-yield reward checking accounts come in. Rates on these products are tiered and based on qualification criteria that not every account holder will meet, which provides a COF discount that other types of deposit accounts can’t match. For example, the median promotional rate nationwide for high-yield, reward-based checking accounts was 1.98% in 2013, according to our data. The median COF, however, was 0.94%, representing a 52% discount. By comparison, a 3.70% APY CD has a COF of exactly 3.70% (the average 3-year rate prior to the 2008 economic collapse).
That COF discount on reward checking only increases as rates rise. A 52% discount on 4% is more than a 52% discount on 2%.
In addition to the COF benefits, high-yield checking accounts can grow banks’ core deposits, providing a stable source of funds for lending, while helping cultivate longer, closer relationships with their customers. By providing customers with a product that drives loyalty and regular use, community banks are staying top-of-mind with their customers and providing them with a product that’s of immediate value. The results are noticeable when it comes to the bottom line. According to an analysis of more than 600 of our clients in 2013, the average lifetime value of a high-yield, rewards-based checking account is $2,192. For a traditional checking account, it’s just $576.
Rising interest rates will affect all banks, in one way or another, and now is the time to get ahead of potential pitfalls. Whether interest rates rise in two months or two years, the addition of high-yield, rewards-based checking accounts can help you weather the change – and boost the value of your customer relationships in the meantime.
Mr. Foster is chief financial officer of Austin, Tex.-based BancVue. He can be reached at Jeremy.Foster@bancvue.com.