Shifting customer and competitive dynamics pose new challenges, opportunities in banks’ search for non-interest income

In late 2010, West Monroe Partners worked with a mid-sized commercial bank to assess the viability of implementing a prepaid card product. The comprehensive product profitability model developed with the bank included the inputs of customer segmentation analysis and adoption forecasting, in addition to prepaid card vendor pricing structures to provide a comparable view of the proposed prepaid card options versus a traditional bank debit card.

Notably, the primary impetus for the development of the profitability model was not the pursuit of alternative revenue sources or a means of developing customer base; rather, it was a proactive attempt to avert increased Regulatory scrutiny regarding a relationship with non-traditional financial service channels (check cashers/payday lenders) serving primarily unbanked or underbanked clients.  As colleagues Joel Graves and Neil Hartman have previously written (“Unbankable”), this market segment presents an attractive and largely untapped growth segment for banks seeking sources of additional revenue or avenues for philanthropy.

Less than three years later, the prepaid card market tracks for continued expansive growth, largely within the unbanked and underbanked market.  However, as the nature of fee regulation alters the non-interest income landscape and banks scramble to retain service charge revenue (see chart), the dynamics of these products and customer segments have changed and introduced new challenges.  Penetrating alternative customer segments looks less like an attractive option and more like a necessary business decision, while alternative products like prepaid cards are no longer niche players, but legitimate competitors for customer dollars – and not just among the underserved.

Quarterly Service Charges (% of Avg Earning Assets) - Past 10 Years

Quarterly Service Charges (% of Avg Earning Assets): 2003 – 2012

As noted in a recent ATMmarketplace White Paper sponsored by Elan, the unbanked customer has more accurately split into two subsets: those who have never been banked primarily due to underservice by financial institutions and now the “debanked;” those choosing to eschew traditional banking channels in favor of prepaid cards.  To fee sensitive customers, prepaid cards offer the value proposition (real or perceived) of lower cost with the added benefit of built in overdraft prevention.  Equally notable is the thesis of the White Paper; advocating that merchants partner with surcharge free ATM networks to drive the debanked or direct the unbanked from banks to prepaid cards.

Non-interest income challenges are particularly acute for mid-sized and smaller institutions who rely more on traditional fee and service charge based revenue versus larger counterparts buttressed with more diverse sources of revenue.  2012 Call Report data highlights the disadvantage for the middle market; comparing institutions with average earning assets between $50 and $99 Billion against those with between $5 and $49 Billion,  the larger segment has a 1.6% advantage (2.87% versus 1.27%) in total non-interest income as a percentage of average earning assets. Analyzing the components of this metric, the $5 – $49 Billion segment had narrow advantages in service charges (0.23% to 0.21%)  and net servicing fees (.11% to .03%).  However, the $50 -$99 Billion segment claims a much more significant advantage in total other non-interest income sources; 2.64% of average earning assets versus 0.93%  for the $5 – 49 Billion segment.

Clearly, non-interest income headwinds are stronger than ever, and service charge revenue will remain a priority challenge for the industry as a whole, but particularly small to mid-sized institutions.  The industry paradigm should be offense, not defense, and banks will continue to be pressed to drive non-interest income through innovating, diversifying or differentiating revenue sources (see article: “Differentiating the Onboarding Experience for Treasury Management”).

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