This week’s National Pricing Indicator report from Market Rates Insight includes a guideline for structuring and pricing the new interest-bearing Demand Deposit Accounts (DDA), which takes effect July 21, 2011.
The introduction of interest-bearing commercial checking accounts, aka Demand Deposit Accounts (DDAs), brought about by the repeal of Depression-era Regulation Q, is much like the introduction of a new product by a major consumer-goods company in that it represents an opportunity for increased market share and profitability. Yet, banks may also experience adverse effects on existing commercial accounts due to heightened competition and misguided pricing.
Since the category of interest-bearing DDAs is new (with the exception of credit unions previously offering such accounts), no empirical data is available to analyze historical trends in order to make assumptions and decisions. Therefore, it is critical to obtain some level of competitive data on the account structure and pricing in order to make better-informed decisions.
Competitive information on the structure of the account is helpful in determining how best to position the interest-bearing DDAs. For example, if the competitive set offers only a choice of interest or Earning Credit Rate (ECR) on the new account, you might decide to offer both. At the same time, competitive rate information is critical in pricing the interest-bearing DDA at the optimal point of competitiveness without self-cannibalization.
Flexibility as Competitive Advantage
The interest-bearing DDA is a multi-dimensional product because it can come in three different variations; interest-only, ECR-only, or a combination of both (hybrid). The flexibility of this account can be a competitive advantage if used correctly, and it can also be a disadvantage if not structured in accordance with customer demand.
The competitive advantage lies in offering commercial customers the option to “make your own account” by allowing them to choose the mix of interest and ECR based on their own preferences. For example, a commercial customer may choose to receive ECR up to a certain credit level, and switch to interest thereafter. Or, the customer may choose to use ECR to offset all fees associated with the maintenance of the account, after which the account will start bearing interest. Thus, commercial customers can structure the account based on their cash flow needs and taxation considerations (interest income is taxable). There is, however, a logistical challenge to such flexibility: not every back-office system can handle it. And there is a risk of losing the business to a competitor if you can’t provide customers with the account structure they desire.
Pricing Competitively Without Cannibalization
It is also very likely that the introduction of interest on commercial checking will trigger internal and external shifts of balances. Internal shift refers to a balance flow from other commercial accounts in the same institution; external shift references a flow of balances in or out of the institution.
A balance shift between commercial account types at the same institution is likely to occur at the point of rate convergence, meaning the point at which the interest rate on the DDA is identical to the rate offered on commercial money market (MM) accounts. For example, assuming that the interest rates offered on the
DDA will mirror the rates currently offered on high-yield ($10,000 and over) retail checking accounts,
which is currently at 0.28%, it is likely that balances of commercial MM accounts, currently at 0.26%, will flow to the DDA because the yield and flexibility of the account is greater (see Figure 1).
The same logic applies to maturing commercial certificates of deposit of nine months or less, which currently yield 0.28%. Thus, institutions may cannibalize their own accounts, and, in some cases, pay higher interest for the same balances they already have.
Balance shift among institutions is likely to occur due to the anticipated competition for DDA customers. Currently, a large number of high-yield retail checking accounts are priced above the national average, which indicates heightened competition (Figure 2).
Therefore, the main challenge for banks that are going to offer interest-bearing commercial DDAs is how to price them at the optimal point of competitiveness without cannibalizing their other existing accounts. The only way to achieve both objectives is by obtaining current, comprehensive and precise competitive data that will help pricing managers establish the correct pricing point.