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.
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Another aspect is indirect benefits from the rewards checking account to the account holder and the bank. Beyond the checking account itself, the bank is trying to build a relationship. The rewards checking account gives small banks a chance to be noticed and be competitive with big banks and online saving accounts. Being local helps the bank understand the customer closely. So usually loan rates are flexible and lower (this I can verify first hand). Also, the quality of customers of the bank improves a notch.
I was a rate chaser myself and moved large chunks of money online. But finding a great local bank changed all that. I have a great relationship with the local bank and they were supportive and helpful with a small mortgage (less than 50K) I wanted. The big banks ditched me altogether saying I wasn’t worth it to them.
I dont understand all the numbers by BancVue: $2.15 for statement expense p/ account? (It costs 0.357 for most corporations that send alot of mail per month by USPS, 1st class. Customized stationary paper, printer ink, envelopes do not cost that much?) 7.2 check-card transactions per month? (Why would someone use a checkcard with their FreeChecking instead of their credit card? ChaseFree Checking says you need 5 “credit’ transactions with debit card to avoid a fee; Citibank Checking requires 2 or 5 “credit” transactions to avoid fee for certain accounts.) Processing expenses? (What exactly is this? Is this for processing written checks, deposits, ACH clearings?) NSF revenue per account? Why do they think this is higher for Reward Checking, and why is it only at 16.09 or 17.12? Most banks, both local and the big ones, charge $25-35 for NSF. Debit card revenue for FreeChecking for 7.2 transactions is only $2.18? (Is this based on “debit” transactions or “credit” transactions with checkcard?) If it’s debit visa, then it makes sense because Visa Interchange rates for debit transactions are usually 10-20cents per transaction plus about 1.5-1.75% fee. Lastly, where are they getting ATM refunds as $1.05/month for rewards?
I think there are alot of people with the following mindset: Reward Checking without the requirements may still be better than the big-banks. First, the fees for several bank services are either the same or usually somewhat less. Second, there is interest, usually equal or abit more than the big-bank’ interest checking accounts. (ie. if you dont meet reward checking requirements, you still earn 0.10 or 0.15 or 0.20 or 0.25%). The big-banks either offer no-interest, or 0.01 or 0.05%. Third, if there’s several branches of the local bank nearby, then you have access to the bank’s ATMs without a fee (of course, if you use another bank’s ATM and dont meet the requirements, you will pay similarly to what you used to pay. $2 for using wrong bank atm, and usually at least $2 to the atm owner). Fourth, you may get other incentives from that reward checking bank for their other services, such as a mortgage loan or other bank product. Either way, there’s probably a small group of people who will have the maximum balance, who would do all the requirements (nothing more and nothing less, and will try to spend the least amount with their “credit’ debit card) to get the high yield interest rate and the ATM refunds.
Harry Sit says
SavingEverything – I don’t know the answers to your questions about the BancVue data because those are from BancVue, not me, and I don’t work for a bank. I can only give some guesses.
$2.15 account statement – Maybe a little high, but hardly matters in the overall comparison.
7.2 check card transaction in a month – Some people prefer to pay with debit card for small amounts. They don’t want to get into debt, or if they already carry a balance on their credit card, they don’t want to add more to their debt.
$2.18 debit card revenue – At 1.5% + 10 cents for 7.2 transactions, it means the average transaction size is about $14. Doing the same for 20 transactions gives the bank $6.20.
$1.90 Processing expenses – I’m guessing bill pay providers charge banks fees. Again, not much difference between free and reward checking.
$16.09 NSF – When you run more transactions through the account, there are more opportunities for NSF, although the higher balance in reward checking help offset it. $16.09 NSF means on average a customer creates one overdraft every two months at $25-35 for each incidence.
$1.05 ATM refund fee – I thought it was low too. There could be several possibilities: the bank has some ATMs in the local area; people are still trained to use the bank’s own ATMs or debit card cashback for cash; not all customers meet the requirement for the ATM refunds.
Overall I think reward checking is a good product for the customers. Make some debit card purchases and you get the freedom to use any ATM.
Reward Checking is an exceptional value for consumers who don’t mind changing their habits ie. excepting e statements instead of paper; using thier debit card intstead of writing checks; making a direct debit to thier account for a bill payment rather than write a check etc. The reason ATM fees are so low is the average reward checking client uses their debit card twice as often as the bank requires…in other words you convert check writers into debit card users. Debit card users don’t need cash therefore the ATM refunds are very low compared to what the average consultant would think.
Interest rates have been lowered in some institutions but the fed funds rate has decreased by 300 b.p in the past two years! Banks have depended on brokered deposits and FHLB borrowings for the past several years for funding. How does this increase franchise value? Core deposits are eroding in the banking system. Reward Checking is here to stay and it will create a long term benefit to banks AND consumers.
Rewards for other ATM says
Banks push you to use billpay services! It’s cheaper for them to process these than your written checks! Banks push direct deposit because they get your money instantly and there’s usually a delay before you actually use it. Banks dont push you too much about using another bank’s ATM. Imagine going to a Las Vegas or Atlantic City casino ATM four times a month, and constantly taking out a little money each time. Or multiple times if you keep losing your $20 or 100? You’re lucky to find a machine charging less than $4. Too bad the banks have monthly maximum limits for ATM reimbursements; otherwise they would be significantly a loss to them.