The report: US banks’ commercial deposits are back on a path to growth
Source: McKinsey and Company
Why we picked this report: Deposit growth is of paramount importance to financial institutions across the board, and commercial deposits are especially vital given the unpredictability of current saving habits of the fickle U.S. consumer.
Executive Summary
U.S. banks are witnessing a resurgence in commercial deposits after a challenging period in 2022 and 2023. With the Federal Reserve signaling potential rate cuts and the end of quantitative tightening, commercial deposits are expected to grow by up to 4% annually over the next few years.
To capitalize on this trend, banks must focus on developing deep client relationships, implementing nuanced pricing strategies, and positioning themselves strategically in terms of markets and client segments. This report from McKinsey and Company highlights the importance of understanding client price sensitivity and industry-specific trends to optimize deposit growth and improve margins.
Key Takeaways
- Commercial deposits are projected to grow up to 4% annually for the next few years.
- Deeper client relationships provide lower-cost funding opportunities.
- Price sensitivity varies significantly among clients, necessitating tailored pricing strategies.
- Industry-specific differences in deposit rates offer opportunities for strategic positioning.
- Banks need to balance client retention with margin improvement through data-driven approaches.
What we liked about this report: McKinsey offers a succinct analysis of both the reasons for optimism in commercial lending and the nuanced strategies required if banks are to benefit from future growth.
What we didn’t: Some of McKinsey’s prescriptions and recommendations are vague.
The Changing Landscape of U.S. Commercial Deposits
U.S. banks have experienced a tumultuous period in recent years, with total deposit balances declining 7% between the first quarter of 2022 and the third quarter of 2023. This downturn was primarily driven by the Federal Reserve’s quantitative tightening (QT) measures and rapid interest rate hikes, which put pressure on banks’ funding costs and margins.
However, the tide is turning. With the Fed signaling potential rate cuts and a slowdown in QT, commercial deposits at U.S. banks have shown signs of recovery, increasing by 2% between Q3 2023 and Q1 2024. Experts now project annual growth rates of up to 4% for the next few years, presenting new opportunities and challenges for bank executives.
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Strategies for Success in the New Deposit Environment
1. Cultivate Deep Client Relationships
Banks that foster stronger client relationships can access lower-cost funding. Clients with earnings credit rate (ECR) accounts tend to accept lower interest rates on separate interest-bearing accounts. Furthermore, primary banking relationships yield significantly higher returns on equity compared to lending-only relationships—approximately 20 percentage points higher.
To maximize these benefits, banks should consider transaction banking fees as part of the overall client relationship. The increased desire for earnings credits to offset fees has led to a rise in operational deposits, which are typically more stable and less expensive for banks.
2. Implement Nuanced Pricing Strategies
Price sensitivity varies widely among clients, necessitating tailored approaches to pricing. Analysis of over $1 trillion in commercial deposit balances revealed that about 20% of customers with interest rates 100 to 150 basis points below market rates are at the highest risk of withdrawing their deposits. Interestingly, clients receiving significantly above-average rates also showed increased likelihood of shopping around for better deals.
As Fed rates potentially decline, banks face the challenge of adjusting deposit rates. While some clients may accept lower rates, others might demand increases despite falling market rates. Banks that can identify price-insensitive customers will be better positioned to reduce funding costs without significant balance losses.
3. Leverage Industry-Specific Insights
Different industries exhibit varying patterns in deposit rates and behaviors. Sectors such as education, professional services, public administration, and utilities tend to receive lower-than-average rates, while finance, retail, and manufacturing industries often secure above-average rates.
Some sectors, like education and professional services, offer attractive opportunities due to their lower loan-to-deposit ratios, providing stable balances without requiring significant lending commitments. Banks should consider these industry differences when developing their deposit strategies and allocating resources.
Positioning for Long-Term Success
To thrive in the evolving commercial deposit landscape, banks must strike a delicate balance between retaining deposit balances and improving net interest margins. This requires a data-driven approach that considers client-specific price sensitivities, industry trends, and overall relationship value.
By developing deeper client relationships, implementing sophisticated pricing strategies, and targeting the right mix of industries and client segments, banks can position themselves for sustained growth in commercial deposits. As the market continues to evolve, those institutions that can adapt quickly and leverage these insights will be best equipped to capitalize on the opportunities presented by the resurgence in commercial deposits.
Editor’s note: This article was prepared with AI language software and edited for clarity and accuracy by The Financial Brand editorial team.