Immediate steps to tackle deposit mispricing
Preparing for a recession usually includes steps that banks take to maximize interest spread and fee income, offload expensive deposits, and prepare for loan losses that are on the horizon—all while maintaining relationships and liquidity.
To provide guidance for those who have responsibility for deposits and deposit pricing in the current environment, I’ve interviewed a number of deposits executives from regional and national banks to get their thoughts. Based on what we are seeing and applying pricing principles we know from our experience, there are five key steps to consider:
- Unwind your deposit specials immediately.
- Move your liquid and term deposits down together.
- Shorten your liability profile to emphasize a four- to 12-month repricing profile.
- Educate and equip your frontline.
- Prepare for negative deposit interest rates.
Deposit specials are creating interest rate risk
If you are reading this and still have deposit specials in the market, stop reading and go wind them down. A drop of 150 basis points in the federal funds rate in March means whatever rate special or promotion you had at the end of February is now locking you into paying APYs that you don’t need to pay. Remember to balance interest rate risk (paying too much for deposits) against your compliance and reputational risk (violations of terms or perceived bait-and-switch).
Decrease liquid and term rates in unison
A rational pricing model suggests that your borrowing rate is your ceiling for short and mid-term money—but remember not to scare away your customers. Also be mindful of accidental customer arbitrage opportunities. If you are paying 50 basis points on a 90-day term deposit and 15 basis points on a money market account, customers will shift money into the term deposit to maximize yield without giving up liquidity. Make sure you are looking at term and liquid deposits together before publishing new rates.
Problematically, banks are behaving irrationally by holding onto high rates and specials. There is a significant first-mover advantage to bringing down rates and capturing spread to fund loan-loss provisions and preserving net interest income. Asset-sensitive banks will need to move the fastest to drop rates to preserve spread.
Shorten your liability profile
Given the uncertainty, it is best to avoid locking up long-term rates. Keeping a liability-sensitive balance sheet will help your interest expense come down faster than your interest income and will help preserve net interest margin. If we breach negative interest rates in the next nine months, you will want to minimize the amount of money on your books with duration over a year.
Educate your frontline
Most of your branch staff haven’t seen a falling rate environment and are unprepared to talk to clients about why rates are changing and what to do about it. Create a series of talking points for your frontline teams so that your financial institution can support clients who are not financial experts.
While much of the national narrative is centered on how to keep borrowers from defaulting on loan obligations, there has been little talk about support for depositors who need help navigating the options for their savings, including dusting off the old brochures about how deposit insurance works. Customer experience and customer advocacy will be vital on both sides of the balance sheet for banks that want to retain customer trust.
Prepare for negative interest rates
If your core system is not able to process negative interest rates, you will have to implement a fee on deposits for clients. If we reach a point where we need to assess “negative interest” on consumers, it may be easier to increase monthly maintenance fees or increase waiver requirements than to explain how a negative interest rate works (frontline bankers and retail consumers will likely struggle with the concept).
It is not unreasonable to think we will see negative interest rates soon, so evaluate system capability, look at your disclosures, and prepare frontline communications now.
What to do next
The market and the news are moving so fast that we can no longer operate in days; we are now operating by the hour as our strategies and responses evolve. While we hope and expect the market will stabilize, we are also tasked with projecting calm. Maintaining your clients’ confidence in our ability to hold their funds is the most important determinant of how we navigate disruptive market stress.