Introducing a new product is always a head scratcher for bankers. How to price and how to create a promotional incentive are just two of the many difficult questions that bankers have to solve. For example, do you price a new service with annual fees or monthly fees? Do you introduce the product and offer a money back guarantee so there is no risk to try the new product or do you offer it free on a trial basis?
Case Study
Driven by the need to increase fee income, community banks have been raising out-of-network ATM fees which are now at record highs. While helping with fee income, this could be a long-run strategic mistake for community banks and may serve to decrease profitability instead of helping it. The larger banks, such as Bank of America and Wells Fargo, have a customer base that is comparatively less fee sensitive. Their customers will pay for the convenience of their ATM network.
Earlier this week (HERE), we laid the foundation and highlighted the finer skills needed to be an expert in deposit pricing. We talked about how banks destroy value by indexing deposit rates, how banks need to look forward when setting rates and that how understanding depositor behavior is usually the missing piece of deposit pricing.
Starting last December, several large banks (Capital One, Discover, etc.) have started to raise rates. As of the first quarter, community banks have not followed suit but interestingly they have done something almost as expensive – they have decreased fees. As can be seen below, after several quarters of increasing fees, the first quarter of this year saw a decrease in service charges generated from deposit accounts. The result has been negligible as balances are increasing more because of behavioral economics than fee elasticity.
Most bankers do not have a pricing strategy. They price with the competition, become reactive and thus eliminate their bank’s strategic value. Every bank faces a different cost structure, different set of objectives, different risk profile and has different capabilities. Meeting each competitor’s price ensures that you will have the lowest margins in your area over time. You may succeed when times are good, but you won’t when the next shock happens and the cost of credit and capital become monetized.
Last week, we broke down how a quantitative bank may look at credit in order to get more accurate on their credit grades. Most banks do this to make sure they have their loan loss reserve levels correct. However, the better reason to invest in your credit model is to win more loans from the competition, while not being adversely selected. Today, we look at one of those two strategies that a bank might employ to drive out their competition from the marketplace or at least protect themselves from being driven out of business.
Dad used to always ask us – “What is more important – your mind or your body?” It was a trick question and the lesson he was trying to impart was that both are equally important. One is no good without the other and both need to be developed to be equally strong and in concert. The philosophy can be applied to banking as the discipline of pricing is equally important to credit, asset-liability management, risk and strategy. Unfortunately, many banks don’t devote enough resources to pricing loans, deposits and services, and it impacts their earnings.
In case you missed it, Chipotle’s already expensive burrito is going up in price again starting in January. What is going on? Are margin’s shrinking, costs going up? The answer to Chipotle's pricing power lies in the strength of their brand and it is a good lesson for banks.
