How to offer 4% on checking accounts and still make a profit
Anyone working in the banking industry knows that most checking accounts don’t pay a very high APY if they pay any at all. The business of running a financial institution is predicated on paying the lowest, yet competitive rates you can on deposits while charging the highest competitive rates that you can on loans.
So if you’re running a bank or credit union, offering 4% APY on a checking account looks like net income suicide, right? 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.
And we’re going to pull back the curtain on the largely misunderstood category of reward checking.
Here’s how you can maximize reward checking while turning a profit:
Get consumer attention with the promoted rate.
4% is the “promoted rate” (simply meaning you advertise it) and while it 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 eStatement, 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, 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, nationwide, reward accounts provided a median 56% “discount” on cost of funds (COF) in 2018. More specifically, that’s an average COF of 0.92% for institutions offering reward checking.
It’s true that a vanilla, free checking account may feel like a more comfortable way to control your cost of funds, but the reality is that even the snazziest names and marketing can’t cover the fact that you’re selling the most boring banking instrument available to consumers today.
With a high-rate reward checking account, you can advertise a distinctive product and keep your balance sheet fundamentals strong.