For years, banks and credit unions have had very little reason to increase what they pay for deposits, and consumers have become desensitized to even thinking about the benefits of deposit savings rates. Now, the ground is shifting as consumers start to reevaluate their savings strategy.
Much has changed since the industry last experienced a rising-rate cycle in 2004-6. This time, for instance, there’s a new entity in the mix: intense competition from direct banks. These players have been accruing deposits much faster than traditional institutions.
There are three big lessons that can be learned from the last rising-rate cycle for consumer deposits:
Big banks maintained a conservative rate strategy, passing on only a portion of the Fed’s rate hikes.
Customer deposit behavior started changing when rates hit approximately 2.5% to 3%.
The large banks failed to capitalize on this shift until too late, which resulted in the loss of deposit balances.
In today’s environment, the exodus (or inflows) of consumer deposits to and from traditional savings and term deposit accounts is likely to be far greater due to market, technological and changed consumer behavior. So, it’s even more important for banks to accurately detect the point at which consumer behavior changes about where they put their money.
More importantly, banks must prepare for that moment, so they can deftly execute pre-planned product, pricing and marketing strategies that will drive a growth in deposits or help retain their existing book of deposits. Banks and credit unions should “follow the money” by tracking three indicators.
Deposit Shift Indicator #1: Money Flowing Into And Out of The Banking System
Americans have in excess $15 trillion of equity in real estate and $29 trillion of equity in the stock market according to the Federal Reserve Board (Q2 2018 data). In recent years, many consumers have fared well with their investments in both of these vehicles, but at some point, we should expect them to start cashing out from their recent gains. The question is: where might they transfer those gains? Inflation adjusted rates on most deposits are still largely negative. On average, banks paid just 51 basis points a year for deposits per FDIC Q2 data!
We will have to see whether insured bank and credit union deposits will be viable alternatives. However, the Trump Administration’s aggressive trade policies, increasing volatility in capital markets, and other broad macroeconomic changes could contribute to consumers wanting to move their funds to safer forms of investments such as bank deposits.
All in all, relatively low yields on bank deposits will continue to mean the turning point will not be obvious. Which in turn will necessitate more targeted, granular pricing and marketing, versus sweeping plays that assume all customers value rate the same way.
Deposit Shift Indicator #2: Money Moving Between Banks
A bank can easily focus on this by tracking metrics such as “ending balance growth.” Some institutions track metrics such as “acquisition,” “attrition,” and “augmentation” to track money flows into and out of their banks. However, our analyses reveal that the story this time around is more nuanced.
Today, these metrics alone likely aren’t deep enough. Also, these days, data processing and rigor with reporting has improved within banks, making digging beneath the surface more of the norm rather than the exception. Some banks are starting to use transactional data to analyze flows between their bank and other financial institutions. Furthermore, a small subset of banks and fintechs are starting to push traditional boundaries by identifying “rate-sensitive flows” between banks. Specifically, these are a subset of money flows between banks driven by the rate-sensitive nature of certain customers.
Deposit Shift Indicator #3: Money Moving Within The Bank
Money movements between various products within the bank can have significant impacts, both to the income statement and the balance sheet. Transitions into term accounts can increase the duration of a bank’s deposits portfolio, while dramatically increasing the expense profile. On the other hand, transitions from checking accounts into other interest-bearing accounts could indicate that consumers are willing to trade liquidity for rate, thereby changing the dynamics of the bank and credit union deposit portfolios.
Data indicate the levels of money flows from liquid products into CDs have increased more than three-fold in the past three years. Money movement from non-interest-bearing liquid accounts (checking products) into interest-bearing products (savings and money market) have also increased by more than 25% in the same three-year time period.
This is sufficient evidence that an “inflection point” in deposits has arrived.
Strategies Banks And Credit Unions Can Use to Manage Consumer Deposit Shift
Banking providers across the U.S., Canada are evaluating three broad strategies as they prepare for the inflection point:
1. Improve segmentation and pricing strategies. The evolution of analytic tools enables banks to design and implement granular pricing and segmentation strategies in the marketplace. Broadly speaking, most banks and credit unions continue to rely on traditional product- and tier-based strategies. The need to evolve that approach to implement more granular strategies. These should be based on the following characteristics:
- Regional — e.g. San Francisco gets a different rate than Buffalo; geographic clustering where possible to increase signal.
- Behavioral/Performance — Reward certain types of behaviors: e.g. higher engagement with bank, direct deposit, level of activity (various definitions), primacy, balance increases, etc.
- Relationship — Price based on a broader set of deposit products (and possibly expand to include lending and wealth profiles).
- Promotional — Various kinds of front-book, back-book, retention strategies; testing across various pricing levels, duration of promotions; new money versus renewals in CDs; potentially split renewals further based on whether the customer brings in additional new money.
- Channel pricing — Branch, phone, online, etc.
- Customer value — Customer lifetime value, wealth profile, share of wallet, profile based on total assets/deposits, etc.
2. Evolve product strategies and structures. If we can identify and understand specific customer groups, then we can design products that appeal directly to them. Banks are aligning these efforts along two directions. Firstly, they are developing unique product structures for specific customer groups. Some examples of these include introducing the concept of “liquid CDs” with more flexible provisions than traditional CDs to make the term deposit value proposition more attractive; “Upside-down” promotions that pay a higher rate on the first $X in balances (as an alternative to more traditional front -book promotional strategies); “Linked CDs” (e.g. equity-linked) to improve upside potential while managing downside risk.
Secondly, banks are starting to devise an array of “defensive” and “attacking” product strategies. Some banks are doubling down on their liquid interest-bearing products and readying various segmented “defensive” strategies to arrest outflows. Other banks are preparing to launch large campaigns around CDs, certain that most of the action in the future will be centered around short- to mid-term CDs.
3. Take a “platform” approach that spans the fundamental pillars of pricing. In addition to innovating their segmentation/pricing and product strategies, banks must also become more nimble. The ability to shift from delivering pricing at traditional aggregations to levels with higher definitions requires a broader ecosystem of management and delivery competencies. This is an area that offers huge potential, if banks can innovate these key areas:
- Analytics —Incorporate analytics into pricing decisions, including a) pricing response and demand; b) competitive dynamics; c) accounting for changes in customer behavior; d) profitability; and e) price optimization.
- Pricing strategy — Map pricing strategies to portfolio goals and adapt based on competitor movements, shifts in bank costs, and other macro/micro economic changes.
- Central pricing management — Have a transparent, auditable and central repository for all price lists across the enterprise; manage a central API (application programming interface) library for seamless consumption of rates downstream; and finally, account for system constraints on pricing logic.
- Rule logic — Overlay rule logic that incorporates additional customer and product dimensions that were not considered in the analytical process.
- Opportunity management — Capture and manage all opportunities in one place; seamlessly integrate the right price offer management range for each opportunity; and create a single view across customer opportunities.
- Front-line sales enablement —Track and manage exception policies; streamline pricing exceptions and create reports to understand their frequency and impact; and monitor performance of the front-line in a centralized fashion.
- Back-office/front-line consistency — Dynamically ensure that all changes in back-office pricing strategies are reflected in front-line information and behavior.
The trick with all these steps is to be ready to unleash them at the right moment for the appropriate part of the portfolio. What is very clear: a “one-size-fits-all” approach to pricing deposits is not going to work this time around.