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This Month in Retail Banking | July 2021

NEW PRODUCTS, NEW UNCERTAINTY

The Delta variant of COVID-19 is taking hold across the country, creating a new divide among those consumers who are vaccinated and those who aren’t. There are few reports of new U.S. lockdowns so far, although Los Angeles County has reinstated its indoor mask mandate. We don’t know yet if other major cities will follow suit and whether the spread of the highly-contagious variant will slow employer plans to bring workers back to the physical office.

In the meantime, there recently has been a slew of new product developments involving overdraft and “buy now, pay later” services. We explore both products in this issue, making the point that providers must incorporate the evolution of these new features when considering their own product suite.

Next, we examine profitability of retail banking through the lens of ultra-low FTP deposit rates. While many retail banking divisions are struggling to remain profitable, treasury groups would love to see those rates fall even further.

Finally, we look the value of goaling in an industry that is moving fast from a physical to a digital environment. As financial-services providers prepare to set sales performance goals for 2022, additional analysis is required to account for changes in customer behavior.

This issue again incorporates insights from Informa Financial Intelligence’s FBX business, which joined forces with Novantas last month. Stay tuned for more data and analysis from the powerful new organization.

Agenda for This Month

Overdraft Overhaul in Full Swing

The wave of overdraft innovation continues to gain momentum. Although the first bunch of changes to overdraft policies were led by neobanks, traditional banks are following suit. Following PNC’s announcement of Low Cash Mode, Huntington launched Standby Cash and Ally announced that it is eliminating overdraft fees altogether. Other traditional banks have announced new overdraft features and safe accounts that are more consumer friendly.

This momentum isn’t only adding pressure to banks to address overdraft and access to liquidity, but it’s also making its way to consumers who will increasingly demand innovation in this space.

Consumers have recognized and rewarded those with overdraft innovations. The latest Novantas U.S. Shopper study found that traditional and challenger banks with overdraft innovations saw a 2x purchase rate in 2020 relative to their counterparts – and these banks achieved a 42% growth in purchase rate from 2017 to 2020 (relative to the -27% that their counterparts saw). (See Figure 1.)

Figure 1: Overdraft and access to liquidity pump up purchase rate

2020 AVERAGE PURCHASE RATE

CHANGE IN PURCHASE RATE (2017-2020)

Source: Novantas Customer Knowledge | U.S. Shopper Surveys 2017-2020
Note: Bank scores are calculated across markets each bank is present in

Although innovation requires investment, the return in acquisition volume more than makes up for the disruption in fee revenue. Additionally, given the momentum in the marketplace, the true cost will stem from inaction.  Banks that don’t address the issues should expect to lose 60% of overdraft revenue over the next several years. That translates to an average of $40-50 million annual revenue loss over time for a top 100 bank.

Depending on the bank’s investment appetite, there are three potential opportunities to pursue for near-term through long-term impact on distinctiveness and growth. (See Figure 2.)

It seems increasingly clear that inaction is no longer an option.

Figure 2: Potential Actions for Banks

No/Low Investment

DO NOTHING

By taking no action, the bank should be prepared to lose ~60% of overdraft income over the next several years

IMPLEMENT ‘BANK ON’ PRODUCT

Alleviate some regulatory pressure by implementing a safe product; key note is that the outcome will yield limited uptake

Low/Mid-Range Investment

OPTIMIZE PRODUCT SUITE

Optimize current product suite with appropriate laddering of fees & features – typical outcomes yield ~20% lift in profitability and 30% lift in average deposit relationships; this is a harvesting move

PRIORITIZE & POSITION ‘copycat’ OD FEATURES

Maintain competitiveness with the rest of the industry, but bank should be prepared to lose overdraft income by ~10-15% over the next several years; the positioning & packaging will be critical

Drive short-term profitability and deposit growth to fund future product roadmap & innovations
Maintain competitiveness and drive medium-term benefits with sharp prioritization & positioning of existing OD solutions

High Investment

Innovate Overdraft Features

Re-design the overdraft experience with a differentiated overdraft feature to achieve acquisition lift in the near-term

Complete Fee & Product Innovation

Redesign and innovate in the access to liquidity space beyond just the overdraft space to achieve differentiation – and lift in acquisition in the long-run

Innovate for the long-run to meet the unmet need of access to liquidity to drive differentiation & paved acquisition

No/Low Investment

DO NOTHING

By taking no action, the bank should be prepared to lose ~60% of overdraft income over the next several years

IMPLEMENT ‘BANK ON’ PRODUCT

Alleviate some regulatory pressure by implementing a safe product; key note is that the outcome will yield limited uptake

Low/Mid-Range Investment

OPTIMIZE PRODUCT SUITE

Optimize current product suite with appropriate laddering of fees & features – typical outcomes yield ~20% lift in profitability and 30% lift in average deposit relationships; this is a harvesting move

Drive short-term profitability and deposit growth to fund future product roadmap & innovations

PRIORITIZE & POSITION ‘copycat’ OD FEATURES

Maintain competitiveness with the rest of the industry, but bank should be prepared to lose overdraft income by ~10-15% over the next several years; the positioning & packaging will be critical

Maintain competitiveness and drive medium-term benefits with sharp prioritization & positioning of existing OD solutions

High Investment

Innovate Overdraft Features

Re-design the overdraft experience with a differentiated overdraft feature to achieve acquisition lift in the near-term

Complete Fee & Product Innovation

Redesign and innovate in the access to liquidity space beyond just the overdraft space to achieve differentiation – and lift in acquisition in the long-run

Innovate for the long-run to meet the unmet need of access to liquidity to drive differentiation & paved acquisition

Source: Novantas Analysis

BNPL is Growing and It’s Here to Stay

Disposables incomes are down and the prices of goods and services are up, forcing many consumers to live from paycheck to paycheck. This and other economic factors helped “buy now, pay later” services (BNPL) grow by 215% year-over-year in January and February in the U.S. alone.

BNPL is becoming an incredibly competitive marketplace with a number of banking stalwarts and technology providers moving in, assessing and developing the many nuances that come with delivering any digital banking product or service. Those leading the way have raised the profile around their BNPL offering, integrated it as “just another payment method” in the purchase journey and provided flexible solutions that align with the user’s finances. By doing so, progressive market participants are capitalizing on established and unique messaging at the point of sale (POS).

BNPL is part of a wider narrative of facilitating clarity of consumer spending within digital banking services. Financial institutions are rethinking their lending practices, such as offering early clearance for paychecks and overhauling traditional overdraft terms and policies. Attention to customer cashflow management has also been prioritized by banks and fintechs, with more apps providing behavioral nudges that offer help to reduce lending obligations.

Cashflow management has become critical for consumers during the pandemic as economic and financial circumstances changed – and not just for those on low incomes. More than a third of U.S. consumers had used a BNPL service by July 2020. By March, the figure was 55.8%.

For many, BNPL offers flexibility, protects from digging into savings safety nets and is a safer option than traditional debt facilities. For millions of Americans, it’s an increasingly valuable product. For those moving into the market and perfecting at point of sale, opportunities abound. Goldman Sachs and Apple clearly see the prospects of offering POS installments with their recent BNPL partnership announcement.

The Value of Retail Banking in Today’s Rate Environment

Today’s ultra-low rates have put pressure on bank profitability, and no business has felt that more than retail banking. As interest rates have remained at record lows for more than a year, FTP deposit rates have continued to come down. Based on Novantas benchmark rates, the typical FTP credit rate for checking accounts is at record low ranges of 100-175 bp at most banks. Combined with shouldering the bulk of legacy branch costs, core technology spend and marketing budgets, retail banking divisions are struggling to remain profitable.

Most bank treasury groups have little sympathy for this. Banks are flush with deposits and are struggling to deploy the liquidity in productive ways. Treasury groups are skeptical of the long-term duration of the surge deposits that have flowed into banks over the past 15 months. If anything, the typical treasury group would prefer to decrease the FTP credit rate even further.

And while interest rates appear likely to rise in the coming year or two, that won’t provide retail banking leaders with much relief in the near-term. Given the nature of how FTP rates are typically calculated for deposits (pulling in a weighted average of prior month rates via a “tractor”), FTP rates will remain low – even as rates rise. In fact, applying an industry standard deposit FTP methodology that uses long-term averages of rates reveals that even in a more aggressive rising rate scenario in which the Fed increases the Fed Funds rate four times before the end of 2023 (and longer-term rates increase at similar levels of 100 bps), FTP deposit credit rates may actually decrease because 2017-2019 interest rates make up a lower portion of the FTP rate. (See Figure 3.)

Figure 3: Estimated FTP Deposit Credit Rates

Checking (100-175 bp range)
High-yield savings (60-100 bp range)

Source: Novantas Comparative Deposit Analytics (CDA)
Note: *Assumes 100 bp increase in rates

While this is happening, banks will likely need to pass at least some of the rate hike on to customers, further compressing spreads

Furthermore, current FTP systems don’t do a good job of differentiating between the quality of the customer, either. Most FTP credit rates are calculated at the product level. A loyal, core customer and a single service savings customer will receive the same FTP credit rate for their high-yield savings balances despite the fact that the core customer is likely to keep the money at the bank for a significantly longer period of time.

This might lead retail banking leaders to stop focusing on core deposits. Afterall, they provide little value in today’s rate environment and that is unlikely to change in the near future, right? But the better bank management teams know that core customers (and their low-cost deposits) are the lifeblood of any bank. Rather than de-prioritizing gathering core deposits, they are doubling down.

Top bank management teams know that now is the time to focus on acquiring primary customers. With that comes more transaction-oriented fees; deeper relationships, including in lending and wealth management; and longer duration relationships. All of this will increase value both in the short- and long-term.

Don’t let the current FTP system get in the way of keeping your eye on the prize – primary, core deposit customers.

Planning for a “Normal” 2022

After two calendar years of pandemic-impacted branch sales performance and retail branch incentive “overrides,” we are already looking forward to a “normal” 2022. With fundamental changes in customer behaviors, however, can we ensure that 2022 will look like 2019? And do we really want it to?

As banks and credit unions prepare to establish branch sales performance goals for 2022, an increased level of science is required to appropriately set performance expectations and guide incentive programs.

Goaling analytics take into account the structural opportunity available to each branch combined with past performance to set the appropriate ‘stretch’ for the upcoming year. By grouping branches in look-a-like cohorts of similar opportunity and establish a range of expected performance, banks and credit unions can establish unit or dollar sales performance goals by product.

These analytics provide each market opportunity cohort with a range of performance. (See Figure 4.) Any individual branch within that cohort can be assigned a percentile performance based on previous sales. From there, the bank can leverage a structured approach for increasing (or decreasing) the sales performance expectation for the upcoming year.    This is substantively better than just asking each branch to “sell 5% more.” Such an edict could leave opportunity on the table or position a branch for potentially risky sales behaviors or employee dissatisfaction.

Figure 4: Consumer Checking Sales (Illustrative)

Cohort 3
Cohort 6
Cohort 9
Cohort 9 Branches Prior Performance Targeted Performance Targeted Goal Goal Unit Change
Branch A 225 30th 250 (+) 25 Units
Branch B 285 55th 285 No Change
Branch C 450 90th 400 (-) 50 units

Source: Novantas Analysis

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