Panel Discussion - Interest on Business Checking

by Keith l Dalrymple

Comments Before the Pennsylvania Association
of Community Bankers Legislative Conference

March 19, 2001

Introduction

Federal legislation to authorize Interest on Business Checking Accounts is just around the corner. First, acknowledge that it's coming. Second, do the math so your bank can budget for the eventual loss of interest income and third, find ways to generate new sources of income to offset the income that will be lost. Your bank may already be using some sort of sweep account to pay interest on business checking accounts but; when the new law takes effect, you'll probably have to pay market rates on most, if not eventually, all of your depositors' corporate checking accounts.

My comments today will touch on the effect that paying interest on corporate checking accounts will have on the income statement, and as an offset to lost income; what we're doing at Vartan National Bank to counter the loss. While each of our institutions has differences in their balance sheet structure, the points I will address apply to all of us. I will talk about 1) legislative history, 2) loss of income, 3) the landscape after Gramm-Leach-Bliley, and 4) what my bank is doing to offset the coming loss of income.

Legislative History

Last year, bills were introduced at the Federal level in both the House and the Senate; House Bill 4067, and Senate Bill 576 to repeal the ban on paying interest on business checking accounts. Legislation to repeal the bad did not pass last year; however, its failure was not due to lack of support in Congress, but rather because of some unrelated amendments that were tacked onto the bill.

This year, Chuck Hagel re-introduced legislation as Senate Bill 229 the Interest on Business Checking Act of 2001. Although I believe the proposed "24-Transfers" option to allow corporate customers to sweep from their non-interest bearing DDA into a money market on a daily basis is preferable and gives banks more flexibility in how quickly and to what extent they pay interest on corporate checking accounts; the reality of the matter is, that Interest on Business Checking is coming. There may be a two or three year phase-in period after the law goes into effect; however, the matter-of-fact approach is to prepare (now) for the inevitable to ensure that your bank can offset lost income by creating new sources of fee income.

Last year, Vartan National Bank developed a profitability pro-forma to demonstrate the effect of paying interest on corporate checking accounts. A number of different scenarios were considered, but even the most conservative showed a 20% loss of the bank's annual income, and a most likely scenario to be a loss of up to 30% of income.

Obviously, none of us can afford to lose up to a third of our bank's income without devastating repercussions. If you haven't already done the math, I encourage you to do it - when you get bank to your banks. Although loss of income will vary depending on your individual institution's concentration of corporate checking accounts, seeing the results in black and white is likely to make you much more responsive to the main point of my discussion, which is, how to go about the process of finding new sources of "fee income."

Landscape after GLB

The landscape after Gramm-Leach-Bliley, presents both opportunities and challenges to community banks. The opportunity to easily enter into business lines such as insurance and investments is important to all of us as we face increased challenges from non-banks and shrinking margins as we continue to fight for a "smaller piece of the pie."

The challenge to implement these changes quickly and efficiently without sacrificing performance of the core business of taking deposits and making loans. John Paul Getty once said, "My formula for success is rise early, work late and strike oil." Gramm-Leach-Bliley is our "strike"; the key is how we refine and distribute the opportunities it presents to turn new resources into increased profits for the bank.

I would like to back up a bit to emphasize what I believe, is a key point - timing. A moment ago I said, "the challenge is to implement these changes quickly and efficiently." Community banks that can effectively deliver products like property & casualty insurance, title insurance and other financial services first, are going to have a significant competitive advantage in our future marketplace.

What VNB has done to prepare

During the past year, I've been building consensus at the board level and beginning to implement programs at our bank that I think are critical; such as sale of title insurance, sale of investment products and sale of general lines of insurance to consumers and businesses.

Title Insurance

Our bank formed a title insurance agency during August of last year, and we are already seeing a stream of fee income beginning to show up on the bank's income statement. We estimate an increase of 5 basis points for the banks Return of Assets in 2001 as a result of capturing a portion of title insurance income that, quite frankly, was just "sitting on the table." Formation of our title insurance agency, Capital Area Land Transfer, was not a difficult process to execute, and we are now beginning to see fee income fall to the bottom line.

Investment Services

Regarding the sale of investment products to bank customers, there are many different ways to integrate brokerage services into your bank product lines; however I don't want to spend too much time in this area. The point to be made, however, is that even if you don't think having alternative investments as part of your product portfolio will drive significant income to your bottom line; not having it may drive significant depositors out of your bank and across the street to your competition! At our bank we chose to partner with Raymond James Financial Services and have part-time Registered Securities Representatives at our branches under the auspices of a separate division of the bank, Vartan Investment Services.

Insurance Products

I believe that the greatest opportunity for income following Gramm-Leach-Bliley is the sale of a full line of insurance products to both consumers and businesses. There are different routes you can choose when integrating insurance sales into your bank. To date most bankers have felt that their options were limited to, 1) Buying an existing insurance agency in their community, 2) licensing a bank employee for each line of insurance to be sold, or 3) using a 3rd party program like those offered through bank trade associations or 3rd party non-bank entities.

Generally, banks that have purchased insurance agencies have not been very successful. Likewise, licensing your own employees is fraught with many pitfalls - it's expensive, it's time consuming, and frankly the concept of trying to make insurance agents out of bankers is problematic at best and one that's not likely to be well received in the marketplace. Third-party non bank entities fall short when it comes to dealing with claims; and in fact, many are only offering life and disability insurance at this point, utilizing a telephone call center as the delivery channel. As a rule, property & casualty insurance call centers have not worked; for example, Allstate's 200 employee call center that was set up a couple of years ago failed and is (now) in the process of being dismantled.

Through an un-tried alternative, our bank has "cracked the code" for community banks to sell insurance through their local independent insurance agency or agencies. We have spent significant resources this past year to develop a solution that is not only unique; but, effective.

The solution we developed is to form an Insurance Affinity Group of community banks, to bank together in a cooperative effort to share resources of a major insurance carrier and distribute insurance products to each of the banks' customers through the bank's local independent insurance agent. The insurance carrier and the local agent benefit through increased market share, and the bank benefits by receiving fee income and strengthening ties to its customer base.

The key to the success of this idea is the local independent agent. Community banks have built their business through service to customers and communities and have earned the trust of their bank's customers. The independent insurance agents have done the same in their industry. I'm sure every one of you knows an independent insurance agent who you trust implicitly. In many cases these are 2nd and 3rd generation businesses that have built strong reputations for honesty and superior service. Banding together with these insurance agents allows both parties to benefit.

Absent a corporate structure like our Insurance Affinity Group, in order to sell insurance banks are required to have a licensed insurance agent at the bank for each product line (life, auto, commercial, etc.) to be sold. Under our Affinity Group structure, the Pennsylvania Insurance Department will allow use of a single "common agent" to satisfy state insurance department requirements. The obvious advantage to this is that you don't need to dedicate, train or license your own employees, which is an ongoing costly and time consuming requirement.

Additionally, with our Insurance Affinity Group banks, the local insurance agency and the insurance carrier, do all of the work. The bank simply provides referrals to the insurance agency through the bank's contact employees, statement stuffers and other marketing methods with free marketing materials branded with each bank's name provided by the insurance carrier, free of cost to the bank.

If anyone is interested in finding out how to sell insurance with a turn key program through your local independent insurance agent or agencies, I can show you how to do it.

Thank you for your attention. Following my co-panelist's comments with a different perspective on the impact the authorization of Interest on Business Checking will have on banks, I would be pleased to answer any questions.