How to offer 4% on checking accounts and still make a profit

In a rising rate environment like this one, consumers are looking to financial institutions as a “safe haven” for their funds. This makes for an excellent opportunity to create relationships with new consumers as well as deepen relationships (and loyalty) with current account holders. But how do you make your institution stand out from the rest? A tantalizing rate on a checking account can certainly get you in the consideration set. 

Anyone working in the banking industry knows that most checking accounts don’t pay a very high APY — if any at all. The business of running a financial institution is all about paying the lowest, yet competitive rates you can on deposits while charging the highest possible rates that you can on loans. Simple enough. 

So, it stands to reason if you’re running a bank or credit union, offering 4% APY on a checking account looks like net income suicide, right? You’d imagine your net interest margin is going to shrivel like a sponge that’s been left on the counter too long. In theory, paying out 4% on a demand deposit account sounds like a bad business decision, but in reality, it’s one of the smartest products you can offer your account holders. 

Hold on to your balance sheet — we’re about to pull back the curtain on the largely misunderstood category of reward checking.  

The truth is, you can absolutely maximize reward checking while turning a profit.  

Here’s how: 

Get consumer attention with the promoted rate.

4% is a “wow” rate. If you advertise it, it’s going to get noticed. Which will bring in a good number of new accounts — as well as retain current account holders. And while this promoted rate may apply to any individual account holder’s balance, the reality is that you’re very unlikely to pay anywhere close to 4% on your account base. 

Add qualifying activities that most people do anyway.

In order to earn that high APY, the account holder has to complete a set of qualifying activities designed to make and save your institution money. These activities can include taking an e-Statement, posting and settling 10 or more debit transactions, setting up direct deposit, and more. 

Calculate the “blended rate.”

The high APY is only paid on a limited balance amount, called the balance “cap,” and you set that cap according to your deposit goals. Any balance above that limit earns a much lower APY, like 0.25% for instance. This results in what we call a “blended rate,” where the final APY earned is a combination of the below- and above-cap rates. 

What’s the worst-case scenario for the account holder?

If the account holder doesn’t qualify, they earn the lowest published rate (the average is typically 0.05%) on their entire balance, and the account remains free (as in, no monthly maintenance fee). 

How does all this shake out for your institution?

You want account holders to qualify because their activities make and save you money, while the high rewards build their loyalty, but for those high-net-worth individuals, you can rest easy knowing that your cost of funds (COF) is controlled by the “blended” structure of the account. In fact, the COF discount actually increases as rates rise. This white paper uses simple math to demonstrate exactly how reward checking has a growing advantage as rates rise.  

In fact, nationwide, reward accounts provided a median 64% “discount” on cost of funds (COF) in 2022. A 64% discount on a promoted rate of 4% would result in a COF of 1.44%.    

So, while a vanilla, free checking account may feel like a more comfortable way to control your cost of funds, a high-rate reward checking account allows you to advertise a distinctive product and keep your balance sheet fundamentals strong. 

More importantly, the premium rates of reward checking accounts enable you to retain and bring in new deposits with more engaged consumers. These relationships in turn will lead to more loans and more non-interest income.  

And a more profitable bottom line.