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Predictable Fees for the Underbanked

“What do you mean I have to pay $120 to check my luggage? I’ve been using this luggage without having to pay baggage fees for a long time.”

Sound familiar? It doesn’t just happen with airlines. That is how many of your customers, especially those with lower incomes, react to overdraft and insufficient funds checking charges. They are surprised and angry because it means taking money from another important, planned use. The result is our growing population of underbanked households and the loss of many fee-generating opportunities for banks.

That doesn’t mean these customers stopped using financial services and paying fees for them. It means their fees are now going to check cashing stores, money order vendors and other competitors, even Wal-Mart, for financial services. Why are the fees these competitors charge more acceptable? They are completely known and predictable, unlike overdraft, insufficient funds and ATM fees. So they can be budgeted for. And users feel they have control over their occurrence since they are known in advance.

Unpredictable Fees

The largest checking account fees, for insufficient funds and overdrafts, typically occur at the worst time, when the customer has little or no funds available to pay them.  Debit cards and pre-paid cards have smaller unit fees, but they are just as unpredictable, and build up to a significant cost in a month since fees can come from both the card issuer and the ATM provider.

The banking industry generally designs one checking product to serve multiple customer segments. We do this by requiring customers to maintain a balance to avoid basic account fees. We figure customers choose how to pay for the account by how they handle their money. Further, we think of overdraft and insufficient funds fees as penalties for misusing the account; such fees are theoretically meant to discourage such situations. Yet, banks now depend on them a great deal. These penalty fees represent about 20% of annual industry profits. We depend on these fees for income because we know they don’t really shape customer behavior other than to cost us customers.

If you really want to earn significant fees from checking accounts without customer complaints, attrition and the resulting political pressures, you need to change your approach so your products more completely meet the needs of lower-income households, who pay the vast majority of the penalty fees. The major change needed is to make all your fees predictable as to amount and timing of their payment. Of less but still significant importance is timing when you charge the fees. Ideally you want them to coincide with the period when the household has the greatest funds available.

That means greatly reducing or eliminating penalty fees in favor of a bundled price structure so you collect the target amount consistently over time. Establish a limit on the number of days you will allow customers to be overdrawn or short funds to protect your bank from undue risk. Tell your customers what this number is. This allows your customers to know and budget for the cost of checking and fully understand the critical components of your product. Providing service alerts, for example text messages, when balances are low provides even greater help to your low-income customers in managing their funds.

If you choose to offer a pre-paid card in lieu of checking for the underbanked, consider bundling the access charges into the monthly fee. The predictability will greatly improve acceptance and reduce the complaint and reputational damage risks. You do not have to abandon offering the traditional balance or fee structure for checking. These accounts do an excellent job of meeting the needs of middle- and upper-income customers.

How do you sell these accounts side-by-side so your customers can choose which is best for them? Simply ask about their experience incurring overdraft and insufficient funds charges, or how tight their expense budget is. Behavioral questions such as these are inoffensive and effective for segmenting your customers and helping them open the best account for both of you.

Mr. Merkle is the founder and CEO of Unionville, Penn.-based CashFlow Insights, LLC, a firm specializing in improving the profitability of financial services firms, as measured by return on assets, by improving customer management and loyalty. He can be reached at [email protected].