Will Reward Checking Last In the Long Run?

TFB — Mon, 17 Aug 2009 13:10:00 +0000

You have probably heard of these checking accounts offered by smaller ("community") banks and credit unions. They are branded different names but they work very similarly. The concept is called reward checking. A typical reward checking account offers

no minimum balance
no monthly fee
high yield up to a point (4% up to $25,000 is about average these days)
ATM fee refund up to a point ($15-20 a month)

In exchange, it requires

direct deposit
online statement only (no paper statement)
online bill pay
10-12 signature debit transactions per month

The offer makes reward checking a very attractive option for a checking/savings combo account. The most difficult requirement is the monthly 10-12 signature debit transactions, which can be met by a change in usage pattern.

The reward checking products have been on the market for a couple of years now. They are being sold to community banks and credit unions by a company in Texas called BancVue. In this post I will just call the small banks and credit unions generically "banks." I speculate what’s in it for the banks and whether reward checking will last in the long run.

Whenever this question comes up — "Is it a teaser rate?" — the party line answer is that it’s not. They say the bank is able to offer high yield because it realizes savings from online statements and revenue from debit card purchases. BancVue includes these comparison tables in its rewards checking marketing brochure:

The comparison shows that a reward checking account is nearly three times as profitable to the bank than a free checking account. But if you do a calculation, because a reward checking account has a higher balance, you will see that the net revenue per $1,000 deposit is about 1/3 of that from a free checking account.

Dollar for dollar, reward checking is far less profitable, which shouldn’t be a surprise. Moreover, the savings from online statement ($2.15/month), the higher revenue from debit card interchange fees ($3.99/month), and the higher NSF fees ($1.03/month) are only small factors in this revenue model. Together, they add up to $7.17/month, which also has to be offset by the ATM fee refunds. The $1.05/month number looks low to me when foreign ATM fees are $3 a pop at major banks.

The biggest difference in profit is driven by the net interest income. The spread comes from the difference between the rate at which the bank is able to loan out the money and the rate at which the bank has to pay the depositors. For the reward checking account to remain profitable, the bank has to be able to loan out the money.

A depositor can increase the average account balance 10 fold by moving in money from another bank, but they can’t all of a sudden buy 10 cars and need 10 car loans from the bank. To the extent the bank has more loan demand than it receives in deposits, the balance in the reward checking accounts can earn the spread. When the loan demand is met but reward checking is still pulling in more deposits, the bank won’t be able to earn that spread. At that point, the bank will have to make the account less appealing.

This is already happening at some banks. When the bank first came out with reward checking, the yield was eye-opening. After a while, the yield dropped down to about the same level as other online savings accounts. For example, here’s the rate history of First Credit Union in Arizona:

02/03/08: 6.01% APY
03/05/08: 5.01% APY
05/04/08: 4.01% APY
12/19/08: 3.15% APY
01/21/09: 2.75% APY
03/31/09: 1.75% APY

Source: Bank Deals

The great deal lasted about a year.

Will reward checking last in the long run? I think reward checking as a concept will stay. There will always be small banks that want deposits for their loan demand. At any particular institution though, I doubt it.

Banks that offer reward checking to depositors nationwide are especially vulnerable, because out-of-area customers are more interested in the yield, with little interest in getting a loan from the bank. Banks that limit the offer to local customers have a better chance to stay competitive in their yield.

Even then I don’t see how a small bank can expand its loan sales as fast as it attracts deposits in the long run. When deposits catch up with loan sales, the deal has to deteriorate. When a super-hot deal stops being super-hot, be prepared to move your account or just accept the good, but no longer super-hot, deal. As long as there are ATM fee refunds, a reward checking account still beats a no-interest free checking account at a national bank.

If you are interested in a reward checking account, look for one in this reward checking directory maintained by Ken at Bank Deals. If you do use one, make sure you comply with the 10-12 signature debit card purchases requirement. Banks say only 70% of account holders actually meet the requirement and receive the high yield in any month. Don’t be one of that 30%. If you also lose the ATM fee refund, it can be costly.

Elsewhere in the blogosphere:

Bank Deals: How is 5% Checking Possible? The Math Behind Reward Checking Accounts
My Money Blog: Rewards Checking Accounts: Higher Interest Worth The Extra Trouble?

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Will Reward Checking Last In the Long Run?