A higher interest level: Sizing up the challenges for deposits in 2018
In many ways, 2018 has started very much where we all left off in 2017. Financial Institutions continue to get bombarded with advice about:
- the bank of the future
- the need to prepare for battle with a myriad of fintech initiatives and challenges
- how to serve millennials
- the irruption of blockchain
- the importance of the customer experience
- the need for cybersecurity vigilance, and
- how the branch is dead.
All in all, then: nothing new.
Yet 2017 did bring real, tangible changes that will deliver a direct impact, given that the Federal Reserve executed on three long-awaited rate hikes on top of a December 2016 single move. A look into all the crystal balls out there tells us to expect three more hikes in 2018—perhaps even four.
So with all this gradual upward rate momentum, coupled with the gradual reduction in quantitative easing (QE), why aren’t we seeing more activity in the deposit space?
One simple reason: Many banks, particularly the very largest, have so far maintained low deposit costs in this rate tightening cycle with a deposit beta that has stubbornly held below 20 percent. Simply put, these banks are not passing on very much—if any—interest rate changes to their customers.
For the moment, this beta rate is much lower than those that existed in the 2004 to 2006 period of rate rises; then, beta values ran anywhere from 40 to 60 percent—though it’s also fair to note that the current cycle is one of much more gradual rate increases.
That said, state of play at the start of 2018 suggests that the picture is changing—fast. Looking at overall national average rates across the 12 to 60 months term deposit space, it’s clear that many banks have started to position themselves for a fight to retain and attract client deposits. The market is hurtling toward clear deposit drain and increased deposit costs. Meanwhile, the Fed’s QE reduction will also impact this situation as it removes money from the system and pulls liquidity from the market. This will be felt sooner rather than later.
To add further pain, regulatory changes have started to take hold, such as the liquidity coverage ratios and net stable funding ratios required by Basel III (new international banking regulations designed to promote stability in the international financial system). This will almost certainly create further pressure for banks to seek alternatives to wholesale funding and traditional, long-dated retail core deposits. How much pressure will be felt across the board depends in part on each bank’s loan-to-deposit ratios, the deposit composition they’re holding, etc.
The big challenge most banks face centers on how attract and retain core retail deposits without getting caught up in a rate-shopping exercise, yet still deliver attractive, quality solutions to their client base.
How can we deliver the unexpected? And provide attractive value to our clients and prospects without prejudicing the bank’s funding costs?
For starters, we must respond to the needs of our clients, many of whom seek returns but remain wary of tying up their funds long term given the uncertainty over and speed of rate hikes. At the same time, we have significant conservative-client funds sitting on the sidelines, watching and waiting to see how things play out. They’re frustrated by low deposit rates and equity markets at record levels—but have no appetite to assume market risks and what they see as a ride on a potential bubble.
These consumers desire something that provides either optimized term deposit returns or an ability to achieve returns tied to the market (but with capital protection). One simple way to meet these needs is to show in tangible ways how you value the relationship and can help them achieve their goals.
Examples include initiatives that equip clients with tools to generate and process automatic CD ladder strategies that take advantage of staggered intervals to get the best rates. Then, allow them to compare that tack to a traditional short-term CD investment.
Or, banks can offer clients dynamic pricing strategies on longer term CDs that allow them to program their required, personal liquidity needs. This not only allows you to capture longer term, stable funding, but also moves clients from a pure rate shopping strategy.
And for those consumers sitting on the sidelines with little or no return, and frustrated at watching equity markets outperform all expectations, we need to offer them a way to participate in the same without risk. For these clients, a market-linked CD offers FDIC insurance with income focused dual-rate returns (guaranteed minimum plus potential); a growth-focused offering tied to a participation in the upside; or look-back features to provide extremely attractive, safe returns.
Of course, many banks labor against current systems and operations that cannot support these types of initiatives. But solutions coming to market will offer turn-key, platform-based processing. This will include all operations and legal and market requirements, together with the ability to rapidly and transparently integrate them with all existing bank processing and channel delivery services.
Expect an interesting 2018 for deposit activity. Clear signs show activity already heating up—and the winners will efficiently deliver value and the unexpected to their clients. Yet they will also retain reasonable control over funding costs and avoid a dangerous race to the bottom on rates and margins.
Let the others pick up while they left off. These banks will be too busy watching their business pick up … and take off.
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