With the gradual rise in the fed funds rate over the last two years, higher earnings allowance rates are creeping in ever so slowly. Whether working for a bank, credit union, small business, or a large corporation, higher Earnings Credit Rates (ECR) affect everyone using account analysis. Have you ever wondered what effect the rate hikes have on account analysis and / or bank fee analysis?
At the risk of stating the obvious, higher earnings rates in account analysis will yield a correlated decrease in a financial institution’s (FI’s) non-interest fee income. This most obvious outcome though has numerous “not so obvious” downstream effects.
Banks and other FI’s have become very accustomed to flat ECR’s, so flat in fact that FI’s have not changed them for years. The thought of changing these earnings rates on a monthly basis, as was common practice 20 years ago, is now an entirely new concept. Who is going to make the change? How is it going to be approved? What will be the bottom line cost to the FI?
For those FI’s that do not adjust the ECR standards monthly, it is likely you have already seen an increase in the volume of earnings credit rate exception requests for accounts. Hopefully, there is an approval process in place. Looking ahead, how are these ECR exceptions being managed? Do they ever expire?
With ECR’s on the rise, surely these rates are now changing how FI’s compete with one another. Clearly, it would be difficult to compete if you are offering the worst earnings allowance rates in town. Corporate treasury take note, ECR’s are more negotiable today than they have been in 15 years, but you will need to press for higher ECR’s.
The real impetus for this article came from a realization of not being asked about “customer profitability” or “longer / non-monthly compensation cycles” in account analysis for what seems like years. With rates at rock bottom and so many accounts in deficit positions, it is no wonder the use of non-monthly cycles has diminished over time. With little earnings allowance to speak of in the first place, there is just not much to roll from one month to another. As interest rates rise and changes to the ECR become more fluid at FI’s, savvy corporate treasurers likely will be (or should be) asking for longer compensation cycles once again.
With more businesses ending up in excess balance positions, FI’s will have a difficult time knowing who their best customers really are (if they are not already struggling). Looking back a few years, it has been easy to see where all the fee income has been coming from. It is not so easy when that fee income is swallowed up in earnings allowance due to higher ECR’s. For FI’s who have a system set up for profitability measurement (which requires service cost factors, yield rates, bottom line fee income, etc.), you will learn more about your customer’s real value from profitability measurement numbers than fee income on its own. For corporate treasurers, if your bank fee analysis does not contain concession pricing, waived line item fees, etc. then chances are your banking relationship is one of the most profitable of all for the FI, which is a tremendous bargaining lever for you.
There are even more downstream effects of ECR rate hikes. Business customers can count on more price increases from their treasury management partners because revenue reduction (due to higher ECR’s) is too difficult to swallow for FI’s that have become so accustomed to the higher fee income. Rising rates have made price lifting more important than ever. From a corporate perspective, the same can be said for contract pricing that extends through time. One could also conclude that with higher prices for services, the quality of the services provided will come under more scrutiny. With higher unit prices, there will be higher expectations.
While the Dodd-Frank Reform Act passed almost 10 years ago, it has not been until now (with rising ECR’s) that FI’s are finding a thirst for interest to be paid on excess available balances. Banks are competing for large balances with interest credit rates. One could argue that FI’s are now more willing to offer a hybrid analysis product to businesses because of the interest on reserves (and excess reserves) they are enjoying from the federal reserve. The higher fed funds rate is being followed by higher ECR’s and appears to be making a hybrid analysis product more attractive.
When considering the effects of higher ECR’s on a broader scale, one might wonder which accounts belong on an account analysis service in the first place. An account analysis product allowing an earnings credit has always been considered a “service” for the customer. Over time, it has become difficult to think of “account analysis” as a service to the customer when so many accounts end up in a deficit position and are auto-debited.
Over the last few years, there has been a significant increase in the number of FI’s wanting to provide treasury management services and generate more non-interest fee income. One might even say it has even been a bit of a gold rush. Higher ECR’s though, may make the transition into TMS offerings more challenging for smaller community banks and credit unions and certainly reason for them to sharpen their pencils before they make such a leap.
Written by Bill Andrules, Redbridge Senior Advisor. To learn more about Bill or CAA Insight visit https://www.caainsight.com/.