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The Highly Exaggerated Death of Free Checking

The Highly Exaggerated Death of Free Checking

Source: BAI Banking Strategies

Far from being wiped out by overdraft and interchange reform, free checking remains a viable and flourishing product strategy - with some enhancements.


For the past two years, we’ve all heard the mantra: free checking is dead. It was widely assumed in the industry that free checking could not survive – or at least flourish – in the wake of the damage to its economic model produced by recent overdraft and interchange fee regulation.

To paraphrase Mark Twain, those reports of the demise of free checking have proven to be highly exaggerated. Let’s consider the facts as of September 2011. Although two-thirds of the largest banks with the majority of checking accounts nationally have changed account terms and fees, making free checking no longer guaranteed, they still provide a free checking product linked to simple and achievable behaviors, such as making a direct deposit once a month. Even after these pricing changes, 71% of all consumers in September 2011 still had free checking, which suggests a product not only far from dead but not even mildly wounded. Furthermore, unconditional free checking remains intact at most financial institutions with under $10 billion in assets.

So, why do we still hear the free-checking-is-dead chant? A cynic might argue that the chorus complements the bank-bashing bandwagon. Perhaps, but I propose that the answer has two parts grounded in fact. First, the word “free” has specific regulatory limitations in the financial industry affecting the language rather than account reality. And second, it is not well understood that “free” is a very sound economic and business strategy, not a revenue giveaway. I believe that these answers explain why free checking is thriving, and will thrive as one of the most successful services in the industry for years to come. Further, understanding the sound economics of “free” is critical to financial institutions’ product strategy.

Let me share why “free” is a proven and profitable marketing strategy for many products, including checking accounts, under four classic approaches:

Conditional. The most recognizable of the four is the conditional approach, where a free service is tied to additional conditions. All of us are familiar with cell phone companies offering a free cell phone when tied to the purchase of a two-year contract. Financial services companies offering a free account tied to other activities, such as direct deposit or maintaining a minimum balance, are practicing the same strategy. Giving the account for free is profitable, provided the financial institution earns related revenues and usage. But, unlike the telephone provider, which can market and advertise a “free” cell phone with the requirement of a two-year contract, financial services providers are prohibited by regulation from using the word “free” where conditions related to the checking account exist. The much ballyhooed ending of “free” is not because the accounts are not free in most cases, but rather because they cannot be marketed as such.

Usage. Usage and account activity is really the underlying strategy for most financial institutions. After 20 years of unconditional free checking and the high penetration of checking accounts in the population, 30% of checking accounts – based upon my experience and research – represent the second or third account for households and are used sparingly. The real checking battle, as reflected in big bank pricing changes, is to gain active accounts and usage. Offering a “free” account where related usage drives revenue is as old as providing the razor for free because the sale of razor blades provides usage revenue.

This second classic approach provides a unique opportunity for institutions under $10 billion because of the political intervention of the Durbin Amendment. These smaller banks can still offer and advertise “free” unconditionally, leveraging the revenues they retain under Durbin while larger competitors do not. Research and actual customer behavior documents that consumers shift from financial institutions that do not advertise “free” to those that do. Further, these Durbin-exempt institutions have other proven strategies to increase usage and drive incremental revenue.

For example, debit card usage is known to be the primary transaction mechanism for consumers today and its use correlates to financial institution revenues, retention and relationship depth. Incenting debit card use among non-users and light users drives revenue from increased usage while institutions market unconditional “free” checking. With over half the consumers at the average financial institution having low or no debit card usage, the opportunity to fully onboard consumers and gain added revenue by securing the primary banking relationship is significant. Consumers moving from light or non-use to moderate debit card use generate the largest increase in per-account revenue. Research documents that this is most effectively achieved by offering specific, immediate incentives and rewards for specific behaviors.

Premium Service-Level Pricing. Revenues from usage are always highly concentrated. Between 5% and 20% of the consumers always provide the majority of revenue, through either balances or fees. These “heavy users” have specific and unique needs.

Many Internet companies, for example, have used this “free” strategy while offering a premium service for a fee. Flickr, the photo sharing Internet provider, provides its basic service for free and also markets a premium form of its service for a fee, recognizing that only a small percentage of consumers will use the premium service but that this small percentage drives revenue and profit across the entire customer base. Checking account profitability has always been similarly driven by a small percentage of consumers.

Marketing a basic set of services for free while also offering a premium debit card, premium online service, premium bill pay services, premium family banking services and other premium services will drive profits in the future for financial institutions under a free model. Many financial institutions today, such as M&T Bank, Unitus Community Credit Union of Portland, Oregon, Mercantile Bank of Michigan, and Banco Popular are already doing so by offering premium services around credit score information embedded in online banking, personal financial management tools, a premium debit card, or other premium levels of online banking. A key change for financial institutions with this strategy will be to unbundle pricing and services rather than charge a fixed fee for a large and growing, all-inclusive package of services.

Two-Sided Market. This is a market where a third party has an interest in and funds the transaction between two other parties. The classic example is a newspaper offered for free by a publisher to a consumer and the transaction is funded by third-party advertising. This two-sided market is of course what funds interchange revenue for financial institutions. Financial institutions market and provide debit cards, which are partially funded by merchants who pay the interchange and benefit from simple and secure transactions. While politics have intervened into this market to redefine interchange revenues between the parties, the two-sided interests such as targeted advertising linked to specific transactions offer future profitable opportunities between these parties.

Free checking is thriving because it is driven by sound economics and business strategy, which is why financial institutions should leverage these “free” strategies to drive account revenue even in the confusion of the current political and regulatory environment.

Mr. Giltner is Chief DDA Strategist for Wilmington, N.C.-based Velocity Solutions, Inc., a provider of fee income enhancement strategies and overdraft management tools to community and regional banks and credit unions. He can be reached at

BAI Banking Strategies

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