Wednesday, November 25, 2009

Price competition with more than one price: The case of banks

In case you haven't noticed, banks are clamoring for your money. Lately, I have been surprised at the variety of ways that banks compete with one another for customers. Here's a sampling of techniques used by the commercial banking industry to attract customers.

Paid referrals from current customers
In June, I wrote about a great deal our bank (ING Direct) was offering: $25 for opening a new account, just so long as you were referred to ING Direct by a current customer like me. ING Direct isn't the only bank that pays for referrals. Here's a list of the deals at our banks.

ING Direct: $25 for the new customer, $10 for each referral.
Citibank: $50 for each referral.
TCF Bank: $25 for the new customer (an additional $100 for signing up for direct deposit), $25 for each referral.

On its face, these banks have stumbled upon a great advertising scheme. They only pay for advertising that works. On the other hand, offering to pay cash to new customers might send a bad signal. After all, what kind of bank would pay their customers just for signing up?

Higher rates for "new" money.
Banks also attract new customers with an eye-catching high rate on a CD for new customers. When most banks were offering 1 percent APY on an 18-month CD, Citibank offered a 2.25 percent APY for new customers. ING Direct did a similar thing a few months ago. I haven't looked at every bank in the industry, but the practice seems to be pretty standard.

Rate bumps for staying with the bank or the same type of account.
ING Direct usually offers a "Rollover Bonus" of 0.15 percent APY when your CD matures. That means that if the current rate is 1.75 percent for a 12-month CD, you will earn 1.90 percent. Let me put that percentage number into perspective: On $20,000, that's $30 more than you would otherwise have.

Of course, banks compete on other dimensions. Some provide excellent service. Others offer additional freedom (use any ATM you want). Others even pride themselves on having many locations in your area. But, with the advent of internet banking, "competition on price" is becoming increasingly important.

I haven't worked out the details, but this setting raises the following (potentially) interesting questions:

1. Why do these different pricing/advertising schemes co-exist within the same market?

2. What characteristics of banks (i.e., long-term survival, geographical location, or quality of management) correlate most strongly with strong price competition?

3. What are the consequences for consumers of these banking services? Are we getting anything substantive out of this competition?

4. Do these banks have different welfare effects in different geographic regions?

5. How important is the effect of consumers gaming the system by signing up for many different bank accounts? Why is it not more important?

I'll leave this open ended for now, but I can imagine that these are important questions facing the banking industry. I would be interested in hearing your thoughts on the issue.

** Oh, by the way, I'm still getting paid $10 for each referral for an ING Direct savings or checking account, so feel free to shoot me your contact information if you want $25 and a bank account with lots of benefits (minimum of $250 deposit). I think the savings account gets 1.3 percent APY now, but regardless, it is a decent rate for savings that you can move around.

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