Will Higher Rates Help or Hurt Banks? The Answer Is “Yes.”

interest-rates-12-28-15.pngWill the long awaited hike in interest rates turn out to be good or bad for U.S. banks? The honest answer is probably yes to both possibilities, depending on the size of the bank in question and how the Federal Reserve manages monetary policy over the next couple of years.

In case you just got back from Mars, the Fed announced on December 16 that it was raising the interest rate on overnight borrowings between banks (known as the federal funds rate) by a quarter of a percentage point. The significance of the Fed’s action had less to do with the size of the increase than with the fact that this was the first time the central bank had raised rates in more than seven years. There was a lot of commentary after the rate hike about how this would impact the U.S. economy, although a strong case can be made that this was actually a vote of confidence in the economy’s long-term prospects. The job market has rebounded since the recession ended in June 2009 and unemployment was 5.5 percent in May, according to the Bureau of Labor Statistics. While the recovery is still a work in progress, Fed Chairman Janet Yellen expressed confidence in the economy’s future during a press conference after the rate increase was announced.

Although the Fed’s central mission is to fight inflation, deflation—which is a persistent decline in asset values and consumer prices—has actually been a much greater risk in recent years. Having cut the fed funds rate to nearly zero, and embarking upon a controversial strategy of massive bond purchases to pump money into the economy—known as quantitative easing—there was little more the Fed could do other than wait for the economy to heal itself, which it largely has. Yellen and the Federal Open Market Committee, the 12-member group at the Fed that actually sets monetary policy, has been waiting for an opportunity to begin pushing rates back up. Clearly the time was right.

How will this affect the nation’s banks? The impact of a quarter-point increase in the fed funds rate should be manageable, at least for now. Comptroller of the Currency Thomas Curry has expressed publicly his concern that some banks might be exposed to interest rate risk as the Fed tightens its monetary policy. Large banks, which tend to use variable rate pricing on their commercial and industrial loans, permitting lenders to reprice them if rates go up, will probably experience less economic impact than smaller banks. Many small banks don’t have the same flexibility to reprice their business loans. So as rates go up, smaller banks could actually see their net interest margins tighten even more as their deposit costs rise.

Still, the rate increase had been anticipated, predicted and over analyzed for so long that no bank should have been taken by surprise. Managing interest rate risk is an important task for management and the board, and the industry has been given ample time to prepare.

Ultimately, the impact of higher rates on the banking industry might be determined by how quickly the Fed tightens its policy. The Fed has said that it wants to continue raising rates gradually over the next few years—the exact term it used was to “normalize” rates but how gradually? Hike rates too quickly and some smaller banks could be stressed if they can’t reprice their loan portfolios fast enough to keep pace. But if banks are impacted disproportionately depending on whether they are asset or liability sensitive (being asset sensitive means your loans reprice faster than your deposits, while being liability sensitive means the reverse is true), one thing that would hurt everyone is a slow-down in the economy. Here, I would expect the Fed to be very careful. Having nursed the economy back to health, I think the last thing it wants to do is tip the economy back into a recession by acting too aggressively.

At the very least, banks should know what to expect, and the Fed—which has been very transparent under Yellen—will no doubt let them know when to expect it.

The Battle Is Back On for Checking Customers

As I was driving to a meeting the other week listening to the radio, I heard back-to-back commercials from two different banks about checking accounts. The first was a super-regional bank promoting that they would pay me $250 to move my checking account to them. The second, one of the mega banks (a top five bank in asset size) promoted a similar message but upped the incentive to $300 to switch.

When I got home later that day, I found a direct mail offer from another mega bank upping the incentive to $500.


I looked closer at the conditions of these incentives and found a similar nuanced strategic objective. These banks (and a few others I found online making similar offers) are clearly not returning to the days of “open a free account, get a free gift.” They aren’t looking for just consumers willing to switch their account to a free account with no commitment other than the minimum balance to open requirement (usually less than $50).

Rather, they are looking for those willing to switch their relationships that require a certain level of funding and banking activity (direct deposit, mobile banking activation, etc.) to earn part or all of the cash incentive. And these banks aren’t offering a totally free checking account.

Recognizing this as the objective, I perused a major online marketing research company to look for competitive responses from community financial institutions and found hardly any similar monetary offers. Those that were similar were mainly promoted just on their respective websites.

So what do these large banks know about these types of offers that community financial institutions don’t know (or deem important enough) to mount a credible competitive response? Reading and listening to presentations made to stock analysts by big bank management reveal that they know they can simply out market smaller community financial institutions, which don’t have or want to devote the financial resources for incentives at these levels.

They also know these smaller institutions’ customers, namely millennials, have grown disenchanted with inferior mobile banking products, and are looking for superior mobile products that the larger banks typically have. They are capitalizing on a growing attitude taking place in the market regarding consumers who switch accounts — 65 percent of switchers say mobile banking was extremely important or important to their switching decision, according to a survey by Alix Partners.

So by out-marketing and out-innovating retail products, larger banks know the battle is on to attract profitable or quick to be profitable customers, traditional ones right down to millennials who never set foot in a branch, by offering an attractive “earned” incentive to move and providing better mobile products along with a wider variety of other retail products and services.

Now community bankers reading this may be thinking, “That’s not happening at my bank.” Well, you better double-check. Last year, 78 percent of account switchers nationally were picked off by the 10 largest U.S. banks (and 82 percent of younger switchers) at the expense of community banks. Community banks lost 5 percent of switcher market share and credit unions lost 6 percent, according to Alix Partners.

And once these larger banks get these relationships, they aren’t losing them. Take a look at JPMorgan Chase & Co. Chase Bank has driven down its attrition rate from over 14 percent in 2011 to just 9 percent in 2014 (an industry benchmark attrition rate is 18 percent). Also from 2010 to 2014, it has increased its cross-sell ratio by nearly 10 percent and average checking account balances have doubled.

With this kind of financial performance (not only by Chase but nearly all the top 10 largest banks), a negligible competitive marketing response from community institutions and a tentativeness to prioritize enhancing mobile checking related products, their cash offers from $250 to $500 to get consumers to switch accounts is a small price to pay.

Combining this with well-financed and marketing savvy fintech competitors also joining the battle to get customers to switch, the competitive heat will only get hotter as they attack the retail checking market share held by community institutions slow to respond or unwilling to do so.

So community banks and credit unions, what’s your next move?

The Big Banks’ Latest Trends in Mobile Banking

mobile-banking-9-10-15.pngBig banks have been committed to working out their mobile strategies over the past two years and are now unveiling the dramatic results they’ve achieved. According to AlixPartners, big banks controlled 67 percent of the primary banking relationships by the second quarter of 2014, while credit unions had 14 percent. Mid-size banks controlled 11 percent, community banks 4 percent and all others at 4 percent. Plus, 78 percent of people who switched accounts went to a big bank, while only 8 percent went to a credit union and the remaining 14 percent to a community bank, mid-size bank or other. It’s an even bigger gap with young people—82 percent of these switchers went to a big bank, while only 7 percent switched to a credit union, and 11 percent to a community bank, mid-size bank or other. The study also shows that in 2014, 65 percent of the people who switched accounts said that mobile played a role in their decision to switch.

Chase Bank, for example, is one of the biggest retail banks in the country and has seen massive gains in retention and customer engagement, along with a steady loss in attrition and branch expense. Over a four-year period, the number of products and services per household has gone up, and attrition rates have fallen to an astonishing 9 percent this year. According to Chase, mobile app users have increased by 20 percent in the past year, mobile QuickDeposit by 25 percent, mobile QuickPay by 80 percent and mobile bill pay by 30 percent.

Not only are these great things for retention, but they are also business strategies that are saving the bank money. Today at Chase, 10 percent of all deposits are made via mobile. Over a seven-year period, teller transactions have been cut in half, driving a tremendous cost reduction. Since 2010, Chase has cut out over $3 billion in costs.

For the past two years, Chase, as well as other top big banks, including Bank of America, Citi, Wells Fargo and U.S. Bank, have been offering the top five mobile services—mobile banking, mobile bill pay, mobile deposits, ATM/branch locator and P2P payments. The list is growing, as three new services have recently become a standard for all of these banks—Apple Pay, pre-login balances and mobile-friendly websites.

Apple Pay
By January of 2015, 300 financial institutions had been approved for Apple Pay, and in April, that number jumped to 2,500. Today there are about 375 active financial institutions using Apple Pay, 250 of which are credit unions.

Mobile payments have a slow usage growth though—only 0.5 percent of people in 2014 with near-field communication (NFC) equipped phones were doing mobile payments regularly, meaning they did at least one mobile transaction per month. According to Deloitte, that number is forecasted to jump to 5 percent by the end of 2015.

Pre-login Balances
All five of the top big banks now offer the ability to check your balance without logging into mobile banking, and it’s a feature that is proving to be one more way to drive engagement and remove a barrier to mobile usage. Customers using Citi’s Snapshot, for example, sign in to mobile banking three times as often as those who don’t.

Mobile-Friendly Websites
Google announced in May of this year that there are now more Google searches on mobile than there are on desktop computers, a trend that greatly influences how people are making decisions to buy products.

In about six out of 10 cases, when people are shopping for bank products, they’re doing online comparisons, meaning banks now have to anticipate the growing percentage of website traffic coming from mobile. Currently, about 15% of banks’ website traffic is coming from mobile, which will only continue to grow.

Not only did Google announce the state of mobile search, but also starting in April, they’ve put a requirement in place that if your website is not mobile friendly, they’ll move the placement down on Google’s search results.

Of the top 10 banks, every single one has a mobile friendly website. Four out of the top 10 credit unions have passed the mobile friendly test.

As customers are flocking to digital services, the big banks are growing stronger. Credit unions and community banks can stay competitive, though, by continuously training their team to have a mobile mission and being disciplined enough to innovate constantly.

Big Banks Deliver Mobile Shopping Features

The five biggest retail banks—recognized by the brand names U.S. Bank, Chase, Bank of America, Citi and Wells Fargo—control over 50 percent of total assets in the U.S. and are driving the mobile banking agenda. In a race to meet the mobile transaction needs of their customers, these banks have all conquered the most basic services that soon almost all banks will have—mobile banking, mobile bill pay, mobile deposit, ATM and branch locators and P2P payments. Now in phase two of mobile banking, these banks are in an arms race to further engage with customers’ mobile lifestyles, particularly by helping people save money when they shop.

U.S. Bank has been previewing Peri, a mobile app that will launch soon that allows customers to instantly purchase products from what they hear on the radio and television or see in a print ad. For example, if you’re watching a TV commercial, Peri can simply “listen” to it to identify the product and find the place where you can buy it.

On the surface, apps like Peri seem a bit futuristic, but many of us actually already have these types of features on our phone right now. The Amazon app uses its “flow” image recognition technology to allow iPhone users to find the product in the app just by pointing the phone’s camera at it. U.S. Bank is simply taking the best in class, “for the future” shopping features and ensuring they can deliver that functionality in a way that helps their customers.

In a recent presentation to bank executives, Dominic Venturo, chief innovation officer for U.S. Bank Payments Services, shared another pilot program that will allow the bank to be a connector between its retail customers and small business customers. With this technology, merchants can see in real time where consumers are using the app and asking to receive discount offers.

If a customer decides “I want coffee,” or “I want lunch,” they just click in the app to request a discount offer. That message is sent to small businesses in the area, which can access a portal showing all the customers who are currently requesting a deal. The merchants that rise to the occasion will pop up on a map on the customer’s app in real time.

According to Venturo, it’s an entirely different way of thinking about search and awareness offers than banking has produced in the past. The program was tested in Minneapolis and saw offer-to-conversation rates in the mid-double digits, which is an extremely impressive redemption statistic.

In late 2012, Chase Bank acquired Bloomspot, a start-up company that used credit card data to allow merchants to target their best, most loyal customers with offers tailored to their specific interests. Bloomspot was started in 2010, and by the time it was acquired, it had around 2 million members and 500,000 merchants, while raising $46.1 million in venture funding. Chase bought Bloomspot for $35 million, taking in both its technology as well as its team. While Chase has yet to announce their exact plans, they’re likely to use the tools that Bloomspot built for their own debit and credit cards and mobile app experience.

Other big banks are also snatching up or partnering with start-ups that offer shopping assistance in the form of budgeting. When BBVA acquired Simple in 2014 for $117 million, they gained only 100,000 new customers but gained the technology that’s likely to steadily grow a massive audience. TD Bank also partnered with Moven in 2014 to offer customers more advanced financial management tools in their mobile app—tools that the online bank Moven had already built for its customers.

The rest of the world, particularly investors, are beginning to take notice of this growing sector. Just last year, there were 250 investment deals involving Fintech start-up companies, and that number has been growing since 2008. More and more, big banks are funding as well as buying some of these best in class start-ups so they can use their fresh new ideas.

While many other banks are just now catching up, U.S. Bank, Chase and other big banks are now on their way to offer products and services that go beyond the basics to impact their customers’ financial wellbeing.

Will the Criminal Prosecutions at Big Banks Trickle Down to Smaller Banks?

In May of 2014, Zurich, Switzerland-based Credit Suisse became the first major bank to plead guilty to criminal charges in the United States, offering a mea culpa to aiding tax evasion on behalf of its American clients. Two months later, the French bank BNP Paribas pleaded guilty to criminal charges involving violations of laws regarding countries sanctioned by the United States such as Iran and Sudan, and settled with U.S. regulators for close to $9 billion. (Banks are not supposed to aid transactions with countries hostile to the United States.) With news of some of the first criminal prosecutions of major banks since the financial crisis, Bank Director decided to ask a panel of legal experts whether smaller banks had cause for concern.

What does the shift toward criminal prosecutions of some of the largest banks mean for smaller or regional banks, if anything?

Smith_Phillip.pngIt is my belief that the criminal prosecutions at the larger banks are intended to have a preventative effect on smaller or regional banks. The idea is that if they can go after the big guys then they certainly can go after those of us that are smaller as well. But, smaller organizations should use it as a marketing strategy to show the differences between the large banks and more community or smaller banks who are not engaged in the types of activities that draw scrutiny.

—Philip K. Smith, Gerrish McCreary Smith

Donald_Lamson.pngThe danger is that smaller banks may conclude that the Department of Justice (DOJ) would consider criminal penalties for only the largest, and possibly non-US banks. In reality, it is very possible that under the right circumstances, the DOJ could seek a criminal conviction of a smaller bank. For example, if a bank has committed [anti-money laundering] violations on several occasions, DOJ might want to make an example for similar institutions. It’s happened at least once before, although with different facts. Moreover, the possible systemic repercussions of such a prosecution could be perceived as relatively minor. There have been complaints that DOJ has not brought enough criminal cases following the financial crisis, so widening the net to include smaller entities may be perceived as a credible response to those criticisms.

—Donald N. Lamson, Shearman & Sterling LLP

ShamoilS.pngNothing. There’s a rush to say that holding gigantic institutions criminally accountable means that smaller institutions will be next. But that doesn’t apply here, where you have criminal sanctions for conduct that occurred back in 2006 to 2007. Nothing changes this past conduct —the sanctions are aimed at punishment instead of other common goals (like deterrence, incapacitation, rehabilitation, or restitution). The lesson is more subtle: In the big banks’ bad conduct, licensed professionals knew what was going on but didn’t stop it. Absent collusion by the people entrusted to serve as gatekeepers to the financial system, the mortgage-backed securities could not have made their way into the mainstream and contributed to the market crash. So the easiest way to avoid criminal accountability is to maintain the integrity and independence of your gatekeepers. That’s what the big banks failed to do—and why they were held criminally accountable.

—Shamoil T. Shipchandler, Bracewell Giuliani LLP

Dailey-Michael.pngWhile it is never comforting to learn that federal prosecutors are turning their investigative and prosecutorial eyes toward your industry, small and regional banks should not lose sleep over the fact that the feds are seeking criminal prosecutions at the biggest banks. The targets have been the largest of the large Wall Street and multinational banks; the ones the media and politicians have conditioned the public to despise. It will be a long time, if ever (most likely), that the criminal focus turns to main street banks.

—Michael Dailey, Dinsmore & Shohl LLP

Stanford_Cliff.pngAttorney General [Eric] Holder famously asserted that while a corporation could be prosecuted just as any other “person,” prosecutors should consider the “collateral consequences” on “innocent third parties” including the “corporation’s officers, directors, employees, and shareholders.” Criminal prosecutions of large banks have potentially huge collateral consequences. These collateral consequences are not as pronounced with regard to a smaller bank, but nevertheless will (and perhaps should) cause the prosecutor to think twice. On the other hand, it is also easier for a prosecutor to prove criminal intent in a smaller institution, which is less layered and siloed.

—Clifford S. Stanford, Alston & Bird, LLP

Should Big Banks Be Broken Up?

Many blame the largest banks for our most recent banking crisis, which leads to the question. Should “too big to fail” become “too big to exist?”

While the top five banks have assets worth more than 50 percent of the nation’s gross domestic product, it is clear that the safety and soundness of these institutions is essential for a healthy economy. Several high-profile figures have suggested that the big banks should be dismantled to ensure the health of the U.S. economy, including Federal Deposit Insurance Corp. board member Thomas Hoenig and Citigroup’s former chairman Sandy Weill. So Bank Director decided to poll bank attorneys to find out what they think.

Do you think the five largest banks in the United States should be broken up to lessen their systemic risk to the economy?

Guynn_Randall.jpgI don’t think anyone has made a persuasive case that breaking up the banks will reduce systemic risk. Breaking them up could actually increase systemic risk. For example, take a bank with $1 trillion in assets. Suppose it were broken up into 10 banks of $100 billion each. If the 10 smaller banks continue to engage in the same activities—e.g., taking deposits and making loans—all 10 would be just as likely to fail simultaneously and cause just as much systemic risk. Moreover, if they are less efficient risk managers, they may be more likely to fail. We will also lose the benefits of having banks with balance sheets and global footprints that match those of their customers.

—Randall Guynn, Davis Polk

Robert-Monroe.jpgYes, unless the U.S. wants to move towards the European model of banking containing a very small number of banks.  We have seen in the current banking crisis the near economic collapse of our financial systems and our economy resulting from the near failure of two to three of our largest banks.  We need to spread the risk to our economy to a larger base of banks rather than fewer

—Bob Monroe, Stinson Morrison Hecker LLP

G-Rozansky.jpgEconomic crises (e.g., United States 2007-2009 and East Asia in the ‘90s) have generally originated from common exposures to risks (such as a fall in housing prices or a currency depreciation), rather than from the failure of a large bank bringing down others. Moreover, initiatives underway, including those to improve internal risk management processes and impose greater market discipline on large institutions, show promise as a means to reduce systemic risks. In light of the foregoing—and considering the unknown consequences of a forced break-up on the functioning of the financial system, the valuable services only being provided by the largest institutions, and the broad legal authority U.S. regulators already have to force a downsizing on a case-by-case basis—sound policy considerations underpin a more modest approach to “too big to fail.”

—Gregg Rozansky, Shearman & Sterling LLP

Horn_Charles.jpgNo.  Simply breaking up a bank based on size alone is a blunderbuss approach to systemic regulation, which may not achieve its intended results and may do unnecessary harm to the banks involved. Systemic regulation should be based on a reasoned analysis of actual systemic risk presented by individual financial institutions based on their individual structures, activities and risk profiles. Similarly, the decision to break up a large financial institution should be based only on the same type of analysis, and only if the financial institution poses a plain risk to the financial system, and there are not reasonable assurances that the institution can be adequately managed or regulated. Financial regulators, however, should have the authority to require risk-reduction downsizing or divestments of business lines and activities under appropriate circumstances, subject to clear standards and adequate due process protections.

—Charles Horn, Morrison Foerster