What a Rewards Checking Program Can Do for a Failing Bank

by Kevin on March 23, 2010

In my previous post I gave a glowing recommendation for rewards checking accounts. I truly believe they are one of the best banking products currently available for consumers like you and I.

However, I mentioned there was one major risk to consider before you opened an account. We’ll dig into that today.

How Can They Offer So Much Interest?

Your typical megabank is only willing to give you 0.2% on your savings account and your typical online “high-yield” savings account is currently paying in the 1% to 1.25% range.

Yet these rewards checking accounts are offering you 3.0% to 4.0% on your money. That’s as much as 20 times as much as your typical savings account, and 4 times as much as the online savings accounts.

The skeptic in you should be screaming, how is that possible?!

Rewards Checking Accounts and Hurting Banks

Let’s say XYZ Bank isn’t doing well. Customers are leaving. Deposits are down. And interest generated through lending is significantly down.

Why would they consider starting a rewards checking account program?

Banks need deposits to stay afloat.

You deposit your money. The bank keeps it safe for you, then turns around and lends out 90% of it to someone else. The lending rate has to be higher than the savings rate or the bank ends up losing money.

What happens when this bank offers amazing interest rates? People come and deposit their money. Then the bank takes that money and lends it out. Good loans generate good interest which results in profit for the bank. Win for the bank.

Banks need customers.

You may be thinking “duh!”. Of course banks need customers.

Specifically speaking, banks need loan customers. Customers that generate interest and profit for the bank.

Rewards checking accounts bring in not only deposits, but these potential customers as well. Let’s be honest. They don’t want to just give you a great rate on your checking account. They want to turn around and sell you additional products like credit cards, mortgages, and auto loans.

Again, what happens when the bank offers amazing interest rates? People come into the bank and become customers. Another win for the struggling bank.

Rewards checking requirements generate revenue.

My bank requires 1 direct deposit (or automatic bill pay), online/electronic statements, and 10 debit card transactions per month. Yes, there are some costs associated with these items. The bank has to have the infrastructure in place to handle direct deposits, online banking, and the swiping of the debit card.

The overall idea is to minimize costs by encouraging customers to have their paychecks sent in electronically (rather than having to staff a teller at the bank) and to avoid costs associated with printing and mailing monthly statements.

But there is a great chance that your 10 debit card swipes are going to significantly reduce the cost of offering the program. The bank earns a percentage of every swipe of the card. Not a large percentage, but every penny counts.

Some people (myself included) may only charge $3 or $8 dollars with each swipe, but others will completely change their banking habits and rely solely on that bank for all of their spending needs. The bank generates revenue if you use your debit card to buy $300 in groceries and $150 in gas every month.

There are limits on the great interest rate they offer.

My bank offers a great 3.61% interest rate on our rewards checking account…

…but only up to $25,000. (After that the rate is just over 1%.)

Every single rewards checking account I have seen has a cap on how much money can be deposited to earn the great rate. It is usually $25,000 or $50,000.

This limits the exposure for the bank and gives them a target to try and generate revenue toward.

I mentioned last time that $25,000 at 3.61% is $902.50 per year in interest. Through whatever means possible the bank needs to try and generate $902.50 in revenue from me. That revenue can come in the form of merchant fees from swiping my debit card to interest I pay on a home or auto loan to fees I pay for any investment advice I might receive.

At the end of the day the bank has a pretty good idea of what this program might cost them. There is limited downside (interest paid) and significant upside (additional deposits and customers).

The Risk: Your Great Community Bank is Struggling to Survive

So what’s the risk? That great account you just discovered may just be a marketing ploy to bring in deposits and customers to keep the bank afloat.

That nice community bank with the nice teller and the nice manager that always remember your name may be quietly trying to nudge you toward an expensive financial product to help them keep the branch open.

On the flip side the bank may be well managed and in no risk of disappearing. They may have a great balance sheet and everything is just fine.

How can you tell the difference? How can you tell if a bank is vibrant and healthy, or on its deathbed?

Stay tuned. I’ll show you how to check your bank’s pulse in my next post. (Subscribe via RSS or e-mail updates so you won’t miss the next post.)

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{ 3 comments }

BibleDebt March 23, 2010 at 5:50 pm

It is quite a commitment to start purchasing that many times per month with a new debt or credit card. Unless you are already planning on switching, it may not even be worth your move.

Thanks for the summary, excellent post!

Budgeting in the Fun Stuff March 25, 2010 at 10:53 am

It’s a competitive market…banks should keep that in mind.

Ken @ DepositAccounts March 25, 2010 at 4:21 pm

There’s another risk with choosing a reward checking account at a weak bank. There have been a few struggling banks that had to slash their reward checking rates below 1%. The FDIC is enforcing rate caps for less than well capitalized banks that include caps on interest checking accounts. Unfortunately, the FDIC doesn’t differentiate reward checking with interest checking.

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