Five Ways to Strengthen Your Institution for a Falling Rate Cycle
Banks and credit unions need to rethink funding approaches beyond CDs, focusing on building lasting customer relationships instead of chasing rate shoppers, preparing for tighter margins and potential credit quality issues, being patient with rate adjustments, and breaking down product silos through integrated data strategies.
By Mark B. Egan
We’ve seen this movie before, but it’s been a while.
Not since the early 80s and the early aughts have banks and credit unions needed to manage through a declining interest rate environment. Since both those eras ended in rising failures, a refresher course on how to navigate may be in order.
For financial institution marketers in particular, the most important thing to remember is that interest rates aren’t just about your institution’s spread income—they’re about your customers and your product line.
"Institutions focus on the wrong thing. They see a funding problem — 100% real — but if they zoom out, they’d see a consumer problem underneath that," said Ryan Walker, SVP of Business Value Engineering at Kasasa, a financial services company that partners with small banks and credit unions so those institutions can offer customers more competitive products.
Right now, after years of high interest rates, the American consumer is showing signs of strain, according to the Federal Reserve Bank of Philadelphia. The percentage of people making minimum payments on their credit card rose to 10.75% in the third quarter of 2024, the highest in 12 years. And the percentage of delinquent balances rose to 3.52%, up more than 10% year-over-year. The only positive is that delinquencies remain well below the 6.8% peak of the 2008-09 global financial crisis, according to data from the Federal Reserve Bank of New York Consumer Credit Panel/Equifax.
The underlying message for banks and credit unions is that there’s still time to strengthen product offerings and customer relationships to position your business for the challenges ahead. Here are five strategies and tactics that will enable your institution to meet the uncertainties of the current monetary policy cycle.
Want more insights like this? Check out Kasasa’s content portal: Low-Cost Deposit Strategies
1. Get Your Funding Strategy Right
From the summer of 2022 to late last year, financial institutions lured deposits with high CD rates, with many doubling the portion of their funding that came from such hot money. Now as rates decline, the Office of the Comptroller of the Currency has voiced concern: In past falling-rate cycles, "reintermediation into low-cost deposits was a significant factor contributing to expansion in total deposits," the OCC wrote in December.
But this time, because so many low-cost deposits are already in place, people might be reluctant to add more—resulting in "lackluster" deposit growth through 2025, at around 4 to 4.5 percent, the OCC said. Such growth would be "well below the pace of previous Federal Reserve easing cycles when deposit growth typically peaked at between 8 and 17 percent."
The OCC’s caution flag suggests banks and credit unions have been too conventional in their funding strategies for too long. A better approach, more in keeping with the current moment, would be to offer high interest checking and savings accounts rather than focusing so much on CDs. Not only would this lower the cost of funds as average daily balances fluctuate, but it would also generate transaction fees, improving the institution’s overall income mix.
2. It’s the Relationship, Stupid
The typical CD holder — whose attention institutions so aggressively fought for in recent years — has lower potential for lifetime value. "Rate shoppers are high-churn, single-service customers," said Walker. "They’re older, unengaged, and comfortable with CDs — but they’re not building lasting relationships with the institution." An alternative approach might be to stop chasing such temporary gains. Indeed, CDs establish natural moments for customers to go elsewhere. "A CD creates an expiration date on the relationship. When it matures, the customer re-evaluates, and the institution is back under the microscope," said Walker.
Banks and credit unions would do well to put the effort into building lasting, loyal customer relationships that will endure in any rate cycle—and encompass multiple products, such as a checking account with direct deposit, a credit card, and possibly a car loan or mortgage. Checking accounts, for example, are held by your most loyal customers — on average remaining open for 17 years. (Seventeen!)
To foster loyalty, banks and credit unions should consider offering value through competitive checking-account interest rates, plus other incentives such as travel perks or retail discounts. By attracting the right customers with features they find useful, institutions can ensure stability across changing market conditions and economic cycles.
3. Look Out for Tighter Margins (and Declining Credit Quality)
As the U.S. Federal Reserve cuts rates, margins will inevitably tighten as consumers seek to refinance high-rate debts, such as auto loans. However, this trend presents challenges, particularly as the prevalence of negative equity in auto loans increases. In the fourth quarter of 2024, 24.9% of trade-ins toward new vehicle purchases were underwater, up from 24.2% in the previous quarter and 20.4% in the same period the prior year.
The average amount owed on such loans reached an all-time high of $6,838 per vehicle. This trend is even more pronounced among electric vehicle (EV) owners, with 54% of EV trade-ins involving negative equity. The combination of longer loan terms and rapid rate depreciation, especially for EVs, exacerbates this issue.
Ally Financial is a case in point. Last fall, the bank reported a significant increase in retail auto delinquencies, attributing the rise to consumers grappling with escalating living costs from high inflation. The company noted that delinquencies exceeded expectations by about 0.2%, and net charge-offs were 0.1% higher than anticipated. This led to a 17.6% decline in Ally’s stock, its biggest one-day drop since March 2020 during the height of the pandemic.
Bottom line: financial institutions face heightened credit risks as more borrowers with substantial negative equity seek refinancing or new loans. Once again, a better approach would emphasize relationship-building to cross sell to existing customers, to enhance profitability and reduce risk.
4. Don’t Just Do Something, Stand There
While it may have been a mistake to depend so heavily on attracting customers with rates when they were rising, trying to time the market on the way down might not be the best idea either. To be sure, most banks and credit unions with high-rate CDs tend to cut rates immediately when the Fed eases, which makes sense because CDs tend to move lower in lock-step, and your customers should thus largely stay put, all else equal.
Moving slower might especially make sense for financial institutions that offer high-rate checking accounts — which enable an financial institution to build loyalty while also benefiting from transaction fees. "Some banks keep offering high rates even as the market drops, knowing they’re actually paying less," said Walker. "That makes them heroes in deposit gathering while their competitors scramble."
Keeping that rate in market will leave your institution on offense, picking up new business, even as others have been forced into a defensive posture. Future loyal customers will come for your high-rate checking and stay for your service.
5. Deposits Should Be Withdrawn (From Their Silo)
You would think that when interest rates change, banks and credit unions would adjust rates across all products but research from the New York Federal Reserve finds otherwise. For example, while 12-month CD rates soared in line with the effective Federal Funds rate during the last rate hiking cycle, money market accounts only edged higher while checking and savings rates barely budged.
It almost goes without saying that implementing a coordinated cross-product strategy would enable an institution to double-down on growth opportunities and multiply the benefits of risk mitigation initiatives — whichever direction rates are running. If your goal is to improve credit quality across your business, why not wage a campaign on all fronts? When your institution decides to retreat from rate-driven offerings, isn’t it critical to have an optimized fee-driven alternative ready?
The debit card is a powerful case in point, Williams says: Consider that the average consumer uses their card more than 360 times annually at an average cost of 34 cents, generating almost $125 annually in fees, entirely paid by merchants such as gas stations and retailers.
To achieve this level of command requires an integrated data strategy — something that many financial institutions fail to consider. To break down product silos, it’s critical to break down data silos and integrate insights across deposits, loans, and credit cards. Such an approach enables institutions to engage customers more effectively and turn a challenging market into a growth market.
