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What do you really cost your bank?

By Claes Bell ·
Wednesday, December 28, 2011
Posted: 4 pm ET

A few weeks ago I blogged about a story by American Banker's Victoria Finkle on how much free checking costs to provide, and how those numbers reflect on the sustainability of free checking at some large banks. The upshot was that while each checking account customer costs banks an average of $349, but the average bank revenue per checking account is $268.

Finkle wrote a follow-up recently responding to readers calling for her to look at marginal cost rather than average cost. Marginal cost is the increase in total cost as a result of a business producing one extra unit. Because banks have to do things like keep the lights on at their branches, pay their executives and comply with federal regulations regardless of how many people choose to keep their checking accounts there, the marginal cost ends up being much lower than the average cost per customer.

From Finkle:

"If all of the 'unprofitable' customers were eliminated, very little overhead would be eliminated. So overhead doesn't belong in the equation," said one reader of the original story, who identified himself as Jeff P.

According to the estimates I gathered from Moebs and other industry members, overhead accounts for about 20 percent of each account's average costs. For the hypothetical account costing $350, taking out overhead would bring the cost of the account down to about $280, thereby making a far larger group of customers appear profitable.

"Banks should calculate individual customer profitability on whether or not the customer covers their truly marginal costs," such as processing and sending customers monthly statements, Jeff P. added. "Overhead belongs in the analysis to calculate branch-level or bank-wide profitability -- not individual customer profitability. For a customer what matters is if they contribute something towards overhead."

First off, this post in general shows the value of having awesome, intelligent people reading your blogs. I've been fortunate enough to have a lot of really constructive critiques of my stuff that have led to follow-up posts and produced a lot of value for Bankrate readers, and I want to take a second to thank folks reading this who participate in the comments section in this blog.

Getting back to the topic, I think Jeff P. has a great point here, and looking at marginal cost really gives you an insight into why the big banks decided to back off on debit card fees. The difference between $280 (marginal cost) and $268 (average profit) is a lot smaller than the difference between $350 (average cost) and $268. From the big banks' perspective, charging a debit card fee that helped closed that gap would be great, but if it meant losing a bunch of checking customers, which would do nothing to reduce their overhead costs and would in effect make them a bigger portion of their average costs, didn't make much sense.

Instead, the banks have elected to raise fees on less-common transaction, rather than making a big splash with new fees, perhaps because they don't, in reality, have that far to go to get most of their checking customers profitable. Sure, they're not going to post earthshaking profits on their checking divisions that way, but since for many banks checking accounts are a gateway product anyway, maybe that's not too big of a concern for them.

If banks do indeed have a shorter path to customer profitability than we think, that's good for checking accountholders. Because many of the fees banks are choosing to boost are tied to less-frequent transactions like international transfers and ordering replacement debit cards, customers likely won't notice them all that much. If that's enough to make "free checking" a viable product, that will make a lot of consumers pretty happy.

What do you think? How should banks look at customer profitability?

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December 30, 2011 at 11:25 am

Erik, a couple of points: First, interest rate is tied directly to the federal rate. If banks can borrow money from the fed at a low rate, why would they borrow it from consumers at a higher rate? Sure there is obviously some difference in rate between institutions, but not by a large margin. If rates were around 8%, would you still switch just for a tenth of a percent increase?

Second, the lending market right now is extraodinarily low. Banks typically have far more in deposits then they are able to lend out. So there is even less incentive for a bank to pay higher interest rates.

December 29, 2011 at 4:25 pm

You know, I have a checking account at a large national bank and one thing has always irked me about their checking and even savings accounts. They offer interest rates that are absolutely terrible. We're talking fractions of a percent. In my particular case, I will sometimes have large amounts of money in the account, which will prompt bank employees to try to get me to sign up for some, "special" program, which ultimately is little better than their original rate! So, instead, I move my money every month to a savings account which is listed near the top of bankrate's list each month.

My suggestion to this large bank and others is that they implement protocol which allows employees to offer those with larger balances to enjoy the same or better interest rates as they would get with these other institutions. Instead, it seems they hope someone will simply fail to shop around and keep large amounts of money in an account that yields 0.05% interest? Really? Why not be more open with the consumer and simply cut those with large accounts in on some of the profit they'll enjoy from those balances by offering a respectable interest rate.

I suspect the answer is that it's easier to leave things as they are.

Karen Gordon
December 29, 2011 at 3:39 pm

Save First, you bring up a great point. Customer profitability is directly related to the number and type of accounts held. Banks need to find ways to open more accounts with existing customers to increase profitability and wallet share. In turn if the bank "takes care" of its customers, loyalty to the institution will also increase. It costs less to keep the customers you have than to acquire new ones. Banks are like any other business. They need to make a profit and that is okay. They are in a difficult position of balancing making a profit with alienating customers due to lack of consumer trust in the financial industry.

Save First
December 28, 2011 at 9:33 pm

"How should banks look at customer profitability?"

The largest checking accounts increase earnings while the smaller (and more numerous) free-checking accounts should be viewed as loss-leaders to the credit world.

Banks should be reviewing "customer portfolios" (i.e. ALL banking activity) when determining customer profitability. A free-checking loss that is compensated by a mortgage, car loan, and monthly credit card balance carryover is ideal.

Which do you see more valuable to a bank?

A - A liquid, $200,000 corporate checking account that could move at a moments notice;


B - A $500 free-checking account tied to a $250,000 mortgage for 30 years, a $25,000 car loan for 5 years, and $3,000 average credit card carryover balance?