Everyone who has ever taken economics knows and understands that so long as marginal revenue exceeds marginal costs, incremental  sales will add to profits. It is a basic, nearly self-evident proposition.  Still, I regularly find myself talking with well-paid people in the banking business who insist that that’s not true.   In particular, they argue that it’s uneconomic for their banks to spend money to attract new checking accounts. New accounts will only cost the bank money, they say, since the fully allocated average cost of a checking account tops $200--more than the revenue that account can be expected to generate.

I say, that’s a hopelessly wrong-headed analysis. Banks that cling to it may be headed for the boneyard.

The most commonly quoted number for retail checking account costs is the Federal Reserve’s Functional Cost Analysis.  I am perfectly willing to believe that the fully allocated cost of a checking account at the average bank is $135 or $145 or even $200.  That’s irrelevant. A fully allocated cost is an improper statistic on which to base a business decision. Instead, business decisions should be made by evaluating the marginal variable costs. 

At my clients, for instance, I suspect that the fully allocated costs of checking accounts are roughly half that of the industry average.  The reason is simple. The banks I advise take the allocated portion--the overhead--and spread it much thinner by acquiring more customers.

In contrast to the fully allocated variable cost, the variable cost of opening a new checking account is minimal.  You will not hire any more tellers; you will not buy another reader/sorter; you will not add anyone to the back office.  Your costs will be limited to the paper and postage of statements for the additional accounts, (though some banks buy data services one account at a time).  These strictly variable costs will be somewhere in the $10 to $20 range annually, depending on whether data processing must be included; $14 is a safe bet. 

Some banks will claim that there are more variable costs.  What about the cost of issuing a debit card and the costs of opening the account?  The latter, except for a signature card, is fixed.  The former is not really the cost of a checking account, as you could unbundle the card; charge for it separately; and limit issuance costs to those who are actually going to use it.

"Step function" costs a factor, too

If you are going to get serious about the war for market share, though, you will have to consider some step functions.  Back office costs will rise in steps, but pretty much in proportion to the existing direct costs. What should you look at?  Space, courier services, equipment depreciation, equipment maintenance, data processing, paper, postage, FDIC insurance, fraud losses, and labor are definitely at least semi-variable.  My clients who benchmark these costs typically agree with me that such costs are less than $34 per account per year over time.  A very conservative rule is that you add a back office employee in the call center or the paper processing operation for every 3,300 additional accounts.

Front office costs are also step functions, but a little easier to see.  You add another teller and remodel a branch pretty infrequently.  A proven rule of thumb is that you add one half-time peak-time teller every 1,100 checking accounts.  You can apply your own labor and fringe benefit costs to that, but I like to guess it at $8 per account per year.  Branch upgrades for additional drive-in lanes, additional ATM, or expansion of the teller area are infrequent but very expensive when finally done. The important thing to remember is that change is inherent to success. The happiest day in the life of any retail business is the day it has enough customers to move out of Mom and Dad’s original store into the big new market.  My worst-case estimate is that a bank should set aside a $6 per account per year sinking fund to upgrade offices to meet increased usage.  I have never seen a bank actually spend that much.

$48, not $200

Add it all up—the direct variable cost of opening a new checking account, plus the associated incremental “step-up” front- and back-end costs—and the all-in cost of a new account is around $48. That’s well below the misleading average, fully allocated cost. And more important, it’s much less than the revenue that account can be expected to generate. 

So variable costs are what you should focus on when setting your checking account strategy. If instead you make your decisions based on the average, fully allocated cost of $145 per account, then your costs are headed to $300--as you allow your competitors to steal your market share.  But if you make your decisions on the basis of the most basic economics, then checking accounts are so profitable relative to the marginal costs, that you need never even consider them. 

Many big banks simply don’t understand this—and are thus in the middle stages of a going-out-of-business sale as they allow smaller competitors to take market share. The numbers we use to measure our business determine how we think about it.  Look at the right numbers.

Ralph Haberfeld is a consultant specializing in checking account marketing and profitability for financial institutions. Haberfeld Associates has assisted more than 250 financial institutions in 48 states and the District of Columbia, ranging in size from $60 million to $24 billion in assets, in implementing the High Performance Checking Account Marketing Program.

Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither the author nor bankstocks.com can provide investment advice or respond to individual requests for recommendations. However, we encourage your feedback and welcome your comments on any of the articles on this site. Neither the author nor bankstocks.com has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date. Copyright (c) 2002, bankstocks.com