5 ideas traditional banks have borrowed from challenger banks

May 10, 2022 2:05 PM

Zero overdraft fees. Early payday. Gamified savings.

These are some of the innovations of challenger banks that are gradually becoming more common at traditional financial institutions.

In some cases, such as proactive credit-building, banks are playing catch-up to challenger banks. In other cases, banks offer the more attractive product, such as higher limits on a broader variety of transaction types for customers if they overdraw, even if challenger banks pioneered the effort.

“Where the neobanks come off looking more proactive, more consumer-friendly, is the marketing,” said Emmett Higdon, director of digital banking at Javelin Strategy & Research. “More often the neobanks are positioning it as, ‘We can help you with that problem’ versus the banks saying, ‘We have a savings account for you.’ ”

Read on to learn about five product features that largely have their roots in neobanks but are catching on with traditional banks.

Abolishing or reducing overdraft fees

Challenger banks have long positioned themselves as helping customers avoid overdraft fees rather than punishing them for mistakes. But a rising tide of traditional financial institutions are also ditching this type of fee.

Banks such as Ally Financial in Detroit and Capital One Financial in McLean, Virginia, made a splash in 2021 when they announced they would permanently eliminate overdraft fees. Citigroup will follow in the footsteps of Ally and Capital One this summer.

Some banks are lightening the load for customers without wholly eliminating these punitive fees. Truist Financial in Charlotte, North Carolina, will release two new overdraft fee-free checking accounts this summer. JPMorgan Chase raised its overdraft cushion from $5 to $50 last summer, and will start granting customers a day to bring their overdrawn amount below the threshold later this year. Others are cutting overdraft fees and adjusting related penalties. For example, Bank of America will lower the penalty from $35 to $10 and eliminate nonsufficient-funds fees. The overdraft fee at M&T Bank in Buffalo, New York, now sits at $15, down from $36. KeyCorp in Cleveland will trim its overdraft fee from around $33 to $20.

While competition from challenger banks may be one factor driving these banks, the more significant one may be pressure from regulators, said Mark Schwanhausser, director of digital banking at Javelin Strategy & Research. The Consumer Financial Protection Bureau is scrutinizing the fees charged by banks, while the Office of the Comptroller of the Currency is pushing for reform of overdraft practices.

Michael Nagle/Bloomberg

Giving customers a jump on their paychecks

“Get paid up to two days early” is a refrain many challenger banks, including Chime, Current and GO2bank, dangle in front of their customers. These companies typically make wages available to users when they receive payroll files from their providers on the Wednesday of pay week, rather than waiting to release these funds on the customary Friday.

Banks are gradually warming to the same practice. Capital One Financial, Fifth Third Bancorp in Cincinnati, Huntington Bancshares in Columbus, Ohio, and others began offering this perk to direct-deposit customers last year. Central Pacific Financial Corp. in Honolulu fashioned its first all-digital checking account to include early access to paychecks. In April, Discover Financial Services in Riverwoods, Illinois, added the same feature to its revamped checking account.

"From listening to our customers, we know that early direct deposit access and broad digital offerings are what consumers want and need to feel confident in their financial journey,” John Durrant, executive vice president of retail and small-business banking at the $434.2 billion-asset Capital One, said in a June 2021 interview.

“Customers in our pilot markets told us they loved seeing their paychecks arrive early,” Tim Spence, president of the $211 billion-asset Fifth Third, said in a press release announcing Early Pay last year.

JPMorgan Chase and Citizens Financial Group in Providence, Rhode Island, have also announced plans to enable earlier access to direct deposits of paychecks this year.

The uptake has been slower than that of overdraft policy changes. Early paychecks are not really a big change for most banks to make, said Higdon. “But reducing or eliminating overdraft fees has a much broader benefit to the overall customer population,” he said.

Automating savings into a habit

Automated savings is one area where nonbanks have created more of a “service” rather than simply offering a product, said Schwanhausser.

Challenger banks commonly encourage their users to save using algorithms, automated rules or programs that round up transactions to the nearest dollar so customers can accrue small amounts without feeling a pinch. (The idea of rounding up transactions was originally introduced by Bank of America in 2005, with its “Keep the Change” program.)

Qapital, for example, has built several saving mechanisms into its app, including quirky rules that trigger automatic savings, such as partaking in a chosen “guilty pleasure,” such as buying a morning coffee. The fintech Digit pioneered algorithm-based automated savings in 2015.

Some banks are following suit. Ally Financial, which has $179.2 billion of assets, introduced its Surprise Savings tools in February 2020, including an algorithm that examines a customer’s spending patterns, compares it to their income, and decides how much is safe to move to a separate account. Huntington Bank’s Money Scout analyzes a customer’s spending patterns, income and expenses and then moves small sums of money to their savings accounts. Huntington has $177.6 billion of assets.

As of 2021, eight of the top 25 banks that Javelin surveys offered at least one of three automated savings features: an algorithm, round-ups, or rules that trigger a transfer from checking to savings.

Both banks and fintechs are missing an opportunity to spotlight the most effective saving method, said Schwanhausser: pay yourself first, or setting aside a portion of each paycheck for savings before spending anything. (One exception: U.S. Bancorp in Minneapolis highlights this principle in its Pay Yourself First feature.) Still, “one of the challenges of the pay-yourself-first model is if you don’t save enough at the outset, you are hurting yourself down the line,” said Schwanhausser. “That is where the algorithm savings can be a real eye-opener and play an important role.”

Boosting credit

Bank customers have become increasingly conscious of their credit scores, especially during the pandemic. According to Javelin’s 2021 Mobile Banking Scorecard, 33% of Generation Z and Generation Y customers checked their credit scores on their bank’s mobile app at least once in 30 days in 2020. In 2021, those numbers spiked to 51% of Generation Y and 46% of Generation Z. There was also an 11-point increase for Generation X in the same time frame.

Banks have not fully capitalized on that potential for engagement. Eleven of the top 25 U.S. banks give customers a peek at their credit scores, but they often fall short when it comes to personal guidance on how to improve a score, said Schwanhausser. There is even less credit score information at smaller institutions.

Credit-building tools are more in the realm of challenger banks and fintechs for now, such as Chime’s credit-builder card and GO2bank’s partnership with Experian Boost, which lets users improve their scores by paying bills like video-streaming services, phones and utilities on time. The effectiveness of such tools is debatable.

Still, just as some banks have revised their overdraft fee structures or granted customers early access to wages, “We will see a resurgence of credit-builder products and secured credit cards coming from banks in much the same way,” Alex Johnson, author of the Fintech Takes newsletter, said in an August interview.

Creating their own neobanks

Several financial institutions have embraced the digital-bank model by building (or acquiring) separate brands that mimic challenger banks. They may offer high yields, early payday, or exist entirely on mobile.

These digital banks offer a number of benefits to the banks behind them, such as attracting deposits outside of the institution’s physical geography and giving them the opportunity to experiment with new technologies. For example, Zynlo from PeoplesBank in Holyoke, Massachusetts, gathered $103 million in deposits in its first full year of operation. Cambridge Savings Bank in Cambridge, Massachusetts, adopted the money management tools that originally existed with its digital bank Ivy after analyzing user interactions. Central Pacific incubated and spun out a challenger bank called Swell, which marked the beginning of its banking-as-a-service operations.

Others exist to satisfy a niche, similar to how neobanks such as Daylight, Greenlight and Nerve exist to serve specific audiences.

For example, Iroquois Federal in Watseka, Illinois, has Hitched, a digital bank for newlyweds developed by Nymbus Labs. Bankers Lender from Texas National Bank in Sweetwater, Texas, will target people who work for banks. KeyCorp in 2019 acquired Laurel Road, which has sharpened its focus to serve health care professionals with bank accounts and loans.

“We're trying to advance our balance sheet a little bit,” Walter “Chip” Hasselbring, president and CEO of the $786.4 million-asset Iroquois Federal, said during a panel at American Banker’s Digital Banking conference in 2021. “Our original goal was to attract lower-cost funds. We felt that we could do that digitally without the additional cost of brick-and-mortar, and we wanted to bring in deposits from outside of our general market area without cannibalizing the ones that we already had."