As Rates Rise, Strategic Questions for Banking Grow More Urgent

Prolonged ultra-low interest rates distorted the banking business, making deposits easy to get and loans easy to make. But success in the future will look much different, and a great rethink is beginning as the industry tries to figure out what needs to change and how. In the quest for growth and profitability, everything is on the table — even abandoning mortgages to the nonbank players that already dominate the sector. Accenture's Michael Abbott contends successful deposit-gathering will increasingly depend on building well-rounded relationships with consumers.

Basic blocking and tackling in consumer banking is back again. But at the same time, bankers also are pondering some of those longtime basics.

Is the simple model of collecting deposits and making loans — so reliable in the past — still a viable way to achieve profitability? How should financial institutions adjust their funding mixes now that deposits are no longer “free”?

Does mortgage lending even make sense for traditional financial institutions anymore? Or should they just cede that business to other players?

What can be done about the unbundling that has been fracturing the primary banking relationship? Could a serious return to relationship banking make a difference?

The drastic change in interest rates is prompting much of the reflection, according to Michael Abbott, senior managing director and global banking lead at Accenture.

Ultra-low rates — they were effectively zero for many years — distorted the banking business, he argues “Deposits were worth nothing, and what I mean by that is that bankers paid no attention to them,” Abbott says.

Instead, “they focused all of their attention on the lending side.”

But now, they’re being forced to rethink everything, from how to integrate deposits and lending once again, so that products are not operating in silos, to what those products should be.

Deposit Funding Becomes a Focus Again

A late-April report by S&P Global Market Intelligence noted that several hundred banking institutions, including a handful of large ones, are paying over 4% on certificates of deposit amid a general increase in reliance on CDs and increasing thirst for deposits.

Some institutions — credit unions in particular — have been paying more than 5% for some time, based on periodic checks on sites such as CDValet.com and DepositAccounts.com. (And then there is Apple’s high-yield savings account, available with a 4.15% rate for Apple Card holders only.)

How times change. A bit of historical perspective helps here.

Before passage of the Depository Institution Deregulation and Monetary Control Act of 1980, bank deposit rates were subject to something called Regulation Q. The kind of rates that are considered high now were standard at the time, with many institutions still offering “passbook” savings accounts.

The challenge for traditional financial institutions was that market rates were growing much higher than what they could legally pay. Alternatives, notably uncontrolled money market mutual funds, then a novelty for ordinary savers, began siphoning deposits out of banks, savings institutions and credit unions. A time of double-digit CD rates began.

Uncool in the Eighties:

Admitting that you had more than a pittance in a 5.25% savings account at a bank back then would have been reason for a chiding. Think of it as the equivalent of carrying an old-fashioned 'candy bar' cell phone when your friends all had the latest iPhone or Android.

When a government group — the Depository Institution Deregulation Committee — voted to increase the ceiling on savings rates by half a percentage point, to 5.75% for banks and 6% for savings institutions, the move actually made the front page of The New York Times. Now savers aspire to the levels seen in 1981.

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Putting the Two Sides of Banking Back Together Again

Abbott has been advocating that financial institutions build stronger connections between consumers’ deposit and credit needs. Many people today are mix-and-match customers — getting this product here, that one there, and splitting their business among banks, fintechs and more.

Abbot has suggested responding to this trend with an approach that uses bundling similar to an “Amazon Prime” account. The idea is to create favorable pricing for people who bring multiple financial relationships to one banking provider.

Abbot cites the Bank of America Preferred Rewards program as a good example of how this works. Preferred Rewards relationships are based on deposit levels and Merrill Lynch investment balances.

On the credit side, fee discounts and rate discounts are available for BofA Preferred Rewards members. On the deposit side, the program offers perks like higher savings rates and waiver of maintenance fees, even at the program’s lowest levels. In addition, the rewards program doesn’t carry a fee, unlike the American Express Membership Rewards Program, for example.

Beyond formal programs, Abbott suggests that raising more deposits in today’s conditions hinges on stressing relationships with consumers more, rather than treating deposit products as “one-offs.”

“Most banking products are relatively commodity driven in terms of how they’re presented to consumers,” he says. “Yet when you look at wealth management programs, everything changes. Wealth management customers get a relationship manager.”

As the cost and challenge of raising deposits grows, Abbott thinks financial institutions have to stop treating these funds with such short shrift.

Michael Abbott quote balance sheets matter. Asset-liability management doesn't just happen at the top of the house, it's also possible to do this at the individual customer level

There can be application of relationship banking concepts somewhere between the wealth management level and the small deposit side, where the game isn’t worth the expense.

The alternative to not getting more creative is spending more money. “You can always play the rate game,” says Abbott, but that just leads to consumers thinking of your institution’s deposit options as commodities. Building broader relationships helps you dodge that perception.

“Balance sheets matter,” says Abbott. “Asset-liability management doesn’t just happen at the top of the house; it’s also possible to do this at the individual customer level.”

Banking product design today needs to find ways to wrap the institution around the customer, Abbott insists. “That is a much more stable and more profitable solution than individual product silos.”

He adds: “You can pay now or pay later. You can take the time to design a product that moves you beyond simply fighting with rate. Or you can just pay more and more for deposits.”

Read More:

Your Deposits Aren’t in Charlie’s House Anymore

When the Silicon Valley Bank and Signature Bank debacles were playing out in mid-March, there were media references to the movie “It’s a Wonderful Life,” where James Stewart played George Bailey, head of Bailey Brothers Building and Loan. He headed off a run on his institution by telling people that their deposits weren’t there in the building and loan; they were out in the community, in the form of mortgages on each other’s homes.

There was a time when that was largely true in the United States, and some portfolio mortgage lending still goes on. But the American love affair with the 30-year fixed-rate mortgage and the changing economics of the mortgage lending and mortgage banking businesses have undone the Bailey Brothers idyll.

Abbott says the U.S. mortgage market differs substantially from mortgages in the rest of the world. In Europe, Canada and other markets, mortgages are still often funded by deposits, versus the heavy reliance in this country on securitization through the secondary mortgage market.

Mortgages in many countries also tend to reprice in three to seven years, so banks aren’t taking 30-year interest rate risks, he says. (Both the savings bank and saving association segments of banking went through major crises due to “underwater” mortgages in the 1980s and 1990s. Simply put, the loans earned less than these financial institutions were paying for deposits to fund them.)

The U.S. loves the security of long-term fixed-rate home credit, though. “In a rising rate environment, that becomes a very risky proposition to just let those sit on your balance sheet,” says Abbott.

Jamie Dimon on Mortgages and Banking Relationships

Rethinking banks in the mortgage business isn’t just something consulting firms bring up. It’s been on the mind of the head of the nation’s largest bank. JPMorgan Chase Chairman and Chief Executive Jamie Dimon has brought up the topic of mortgages several times in recent months.

In Dimon’s annual letter to shareholders, he speculated at length about whether the banking industry should get out of mortgage lending entirely. Dimon said that the high cost of originating mortgages and complying with regulations — plus the lack of “a healthy securitization market” — have made the business unattractive, if not unprofitable.

And this is coming from the CEO of one the country’s biggest mortgage lenders.

“If you buy or create a loan at par and put it on your balance sheet at par (think of a mortgage) and internally finance it, even match-funded with 10% capital, you might believe you have a 12% return,” Dimon wrote.

But, “it is only worth par, and, in fact, a small change in that value (because of interest rates and credit spread) could mean that you have made a huge mistake.”

Building a broader relationship around the loan is what creates franchise value, Dimon said. Absent that, banks should consider ceding the mortgage business to the fintechs that already dominate the space, he said.

Surreal Long-Term Low-Rate Days:

When homeowners are doing serial refis, any loyalty and cross-selling can get left behind.

This bolsters Abbott’s argument that the rising rate period ought to push financial institutions to adopt product design and pricing measures to build those relationships. For the foreseeable future, the “zero rate” anomaly is gone.

“We’re going back to the future, without a doubt,” says Abbott, “and we’re seeing it across the board.”

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