Innovation in Business Models

by Scott Loftesness on March 26, 2009

in Banking Industry, Innovation, Scott Loftesness

Scott Loftesness - Glenbrook Partners

We often think of innovation as being primarily technology-driven – but there are some great examples of innovations in banking that were simply business model or process changes involving little, if any, new technology.

Two examples that have proven very valuable financially to US banks in recent years involve simply the handling of transactions being posted to a consumer’s checking account.

  • The first innovation, now over fifteen years old, involves the bank simply sorting the items to be debited against the consumer’s checking account so that the largest value items get posted first. This simple process change has the effect of draining the account balance faster – thereby maximizing the number of other items that will potentially “bounce” – resulting in the most NSF fee income for the bank. This is like “found money”!

  • The second innovation involves how the bank handles overdrafts resulting from debit card activity. When banks were considering debit card issuance over ten years ago, one of their biggest fears was that the use of debit cards might actually lower their revenues from NSF fees. Of course, that presumed that the bank actually wouldn’t authorize, in real-time, a debit card transaction if there wasn’t sufficient funds in the account – declining the transaction at the point-of-sale. Instead, some retail bankers figured out that they could actually risk-adjust authorizations and approve them if they were below some arbitrary threshold amount – and add on an NSF fee at the same time.

Both of these innovations, involving no new technology, have been responsible for billions of dollars of fee income for US banks. The Center for Responsible Lending estimated something like $18 billion in annual fees resulting from overdraft practices.

Naturally, these kinds of innovations sometime provoke consumer and regulatory responses – and both have predictably happened both in the US and the UK. In the US, the Federal Reserve has proposed changes that would require banks to modify their practices with respect to posting overdrafts to give the consumer more control over the behavior they’d like their bank to follow. That rulemaking proceeding is still open for public comment until Monday, March 30. Also, predictably, consumers are voicing their opinions about the practices in a large volume of comments publicly available on the Fed’s web site.

{ 4 comments… read them below or add one }

Broox Peterson March 26, 2009 at 5:58 pm

This is reminiscent of the undergraduate philosophical riddle: “if a tree falls in the forest with no one around, does it make a sound/exist etc.”

If someone figures out a sneaky, greedy way to make money that everyone hates and they pass a law against it, is it innovation?

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Scott Loftesness Scott Loftesness March 26, 2009 at 6:03 pm

Broox, the bankers will wail – which do you prefer, a few folks having to pay these overdraft fees or the elimination of free checking for all?

That’s right: THE ELIMINATION OF FREE CHECKING FOR ALL!

Read today’s WSJ article about overdraft fees – and the comment from William Cooper, chief executive of TCF Bank.

He said it could mean the end of free checking, which his bank pioneered over 20 years ago. “Instead of that monthly charge we get debit-card fees, ATM fees and so on that make up the difference. If you take those away it’s pretty clear what will happen; we’ll have to go back to $10 a month,” for checking accounts, he said. “Then everyone will end up paying for it.”

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Broox Peterson March 27, 2009 at 8:42 am

Mr. Cooper is using the usual wailing points, although I don’t believe that anyone is talking about debit card and ATM fees. When I was a young lawyer working in L.A. I banked across the street at a branch of a Japanese bank. One day the branch manager called me about a check I had written. I had forgotten to deposit my paycheck to cover it, and he was calling to ask if he should pay the check. Alas, that human touch is lost today, although not inevitably given the ease of today’s inexpensive communications options. The innovation I would like to see is a bank that used technology to treat each customer as an individual with individual needs and preferences, which I submit includes the desire to make informed choices rather than trusting (hoping) that their bank is treating them fairly behind the screen. Isn’t social networking showing us one way?

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Scott Loftesness Scott Loftesness March 27, 2009 at 8:49 am

Broox, one of my dreams for years has been a “programmable bank”. Maybe it’s just the IT hacker in me that’s driving it – but I’d love to be able to set things up so the bank did what I wanted in a programmatic way. Perhaps social networking will get us there?

This blog post reminded me of it again: The Psychology of Automation: Building a Bulletproof Personal-Finance System.

Also just stumbled upon WePay.com – another approach to settling up among friends, etc. in an automated way.

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