Better Account Activity Analysis Statements and Earnings Credit Enable Superior Customer-Centricity
Rising Interest Rates Make Earnings Credit and Account Activity Analysis a Priority for Banks
The Frank-Dodd Act removed the prohibition on banks paying interest on corporate customers’ Demand Deposit Accounts (DDAs). It was generally assumed that this would mark the end of “Earnings Credit (EC),” which was commonly employed by US banks to compensate corporate customers for their inability to pay interest on DDAs. The EC is primarily a “pseudo-interest” figure. However, rather than being credited to the customer’s account as “interest,” this sum is adjusted against the fees that the bank charges the customer for services rendered throughout the month. This set off is reflected in the bank’s invoicing.
Because interest rates stayed low for much of the previous decade, EC had no major financial impact on banks or their customers. As a result, banks in the US paid little attention to EC. However, this is about to change since the US Federal Reserve and other central banks have all raised interest rates quicker than projected in recent months. They have also hinted at the impending necessity of higher revisions in the future to combat the plethora of inflationary pressures. More frequent interest rate fluctuations will have a big impact on both banks and their customers.
In the recent decade, the competitive intensity in the banking business has intensified, and incumbents are facing threats from both new and established sources. Because of rapid technology advancements, a bank’s competitive advantage is also defined by how rapidly its software systems enable the bank to adapt to environmental changes. Customers will value EC and interest on hybrid accounts more as interest rates climb. Some banks may need to improve their software systems in order to meet the greater expectations for EC, Account Activity Analysis (AAA) statements, and hybrid accounts.
Customization and Need for Speedy Responsiveness Make EC and Account Activity Analysis Complex
The calculation of EC or interest on hybrid accounts is based on a simple formula that considers the applicable interest rate, the appropriate qualifying balance, and the time period. The complexity occurs because there are several possibilities dependent on the specific corporate customer.
These permutations are the outcome of the bank’s tactics for attracting and retaining business customers as well as increasing profitability. Customized bundling and pricing depending on customer loyalty, size, and profitability have resulted in the classification of customers into several “tiers,” with different rules applying to different tiers. Each month, each customer uses a separate basket of banking services, and these baskets evolve as the customer’s business profile changes, leading to better account analysis in banking.
Rules may need to be adjusted depending on competitor activities and regulatory changes, in addition to being driven by each particular bank’s own development objectives and governance/risk management needs. Banks must be able to make customer-specific changes to how EC and hybrid interest are computed and applied to each individual corporate account in real-time.
The EC And Hybrid Interest Use Cases
A bank must compute and apply Earnings Credit on a regular basis for each qualified corporate customer account. The table below summarizes the many parameters that a bank must consider while calculating EC and hybrid interest for each specific customer account. While the fundamental method for computing EC and hybrid interest is simple to execute, the number of permutations rises as the number of alternatives for each parameter increases.
Parameter
Flexibilities that add complexity
Account type
● Non-interest bearing DDA
● Interest-bearing hybrid: there may be special characteristics associated with individual customer account types
EC interest rate
● Standard rate
● Varying with size/profitability of relationship, extent of specific product penetration etc.
● Determined as a base rate with spread adjustments (+/-, *); the adjustments may need to change with size/profitability of the relationship or relative to overall interest rates in the economy
Rates may need to be set for all accounts in a tier or based on an industry, region, etc.
Balance
For each period, the balance on which EC is calculated is also a variable. EC may be computed on the basis of:
● Average positive balance during the period
● Average balance (taking into account both positive and negative balances)
● Investable balance, which is defined as absolute average balance — reserve requirement
The rule for computing average balance too may need to change over time.
Reserve requirements
Based on regulations and the individual bank’s governance norms, reserve requirements (also known as Collected Balance) may need to be calculated and aggregated at different levels, such as:
● Account
● Customer
● Product
● Branch
● System
Provisions must be made to make changes as may be necessary.
Frequency of EC computation
While banks typically invoice customers on a monthly basis, the EC may need to be calculated at a different frequency — daily, weekly, quarterly, annually or based on contractually agreed billing schedule.
The frequency may also need to change from time to time.
EC adjustments
Whether the EC is to be set off against the total invoice value or only charges for specific services/products are to be adjusted.
EC carry forwards
If the EC in a particular period exceeds the invoice value, whether the excess can be carried forward to the next period; what is the maximum number of months for which excess EC can be carried;
what is the maximum EC that can be accumulated in a financial year, etc.
The example below illustrates EC and hybrid interest calculations:
Assumptions:
Qualifying balance for EC: US$20 Million
Reserve requirement: 0
EC rate: 1%
Days in the month: 30
Monthly bank charges: US$10,000
Interest rate for hybrid account: 0.75%
EC calculation
Monthly Earnings Credit = Balance * (1- Reserve requirement) * EC rate * (Number of days in billing cycle/Number of days in the year)
Hence, EC for that customer for that month is US$20,000,000 * (1–0) * 1% * (31/365), i.e., US$16986.30.
Hybrid interest calculation
Hybrid interest is calculated on the basis of “excess balance” imputed from unused EC. Essentially, this balance is the amount that would have earned interest equal to the excess of EC over monthly bank charges.
Per the above calculation, EC for the month is $16,986.30.
Thus, the unused EC is US$16,986.30-US$10,000.00, i.e., US$6,986.30
Based on this unused Earnings Credit, excess balance is calculated as follows:
6986.30 = Balance * (1–0) *1% * (31/365)
Hence, excess balance is: US$8225804.84
Hybrid interest credit = $8,225,804.84 * 0.75% * (31/365) = $5,239.72
As seen in the above example, banks will need to make modifications to the interest rate, relevant balance, and time period for which the interest is payable in order to compute EC and hybrid interest. The value of these variables will be determined by a variety of factors. Depending on particular customer contracts or the bank’s risk management and governance regulations, certain adjustments may also be required mid-cycle.
The Account Activity Analysis Use Case
Banks offer a variety of services to its corporate customers. These include deposit services ACH, lockboxes, float management and other treasury solutions, international payments, online payments, and so forth. Each service has its own price structure, which typically varies depending on the customer and is agreed upon during the initial deal or renegotiation stage.
Every billing cycle, banks create Account Activity Analysis statements for each business customer. While the structure of the AAA statement varies according to the bank/customer, it will generally include information on the services the customer used during the billing period, unit pricing, product volumes, the associated service costs, applicable taxes, and so on. It will also include information on the qualifying balances for EC and the EC amount. It also aids in the creation of the real invoice. The AAA statements give the customer drill-down details that allow them to reconcile their invoices (monthly, quarterly or as per agreed billing cycle).
Banks, on the other hand, utilize AAA statements to better understand customer demands and forecast future revenue. This information may also be used to negotiate/re-negotiate arrangements with customers. Accurate AAA statements are thus an important source of data and insights for banks to manage revenue, profitability, growth, and customer relationships.
The challenges described in the preceding section also apply to the creation of AAA statements. From an operational aspect, the work becomes more difficult since the various data pieces required for creating AAA statements are generally spread across separate software systems. This is due to the fact that most banks are structured around products and services. When generating a AAA statement for a client, new data must be gathered, checked, and aggregated from numerous systems. Customer statements may contain mistakes if this procedure is not completed properly; there is also the problem of the time required to generate these statements and transmit them to customers.
A Solution Like SunTec Account Analysis Can Address All These Needs Efficiently
SunTec Account Analysis offers banks a strong, secure, and scalable solution for dealing with the challenges discussed in the preceding sections, relating to account analysis in banking. The architecture of the solution enables it to be built as a wraparound or “middle layer” over existing legacy systems, capturing important data from numerous systems via APIs. It serves as a centralized repository for critical data and has the analytical capabilities required for customized pricing and billing, including the generation of real-time data-driven insights that enable relevant sales and account management teams to better manage relationships and provide offers that balance customer needs with the bank’s own financial imperatives for profitable growth.
Because all parameters may be set/modified on the platform, EC and hybrid interest computation and application are simplified; the risk of data not being updated when EC is computed, or AAA statements that are created are eliminated.
The functional flow for EC/hybrid interest computation is illustrated below.
SunTec has already implemented the Account Analysis Solution in banks in the United States/North America and Europe.