Back in January 2022, rising interest rates looked increasingly likely but weren’t yet a reality. In Bank Director’s 2022 Risk Survey, bank executives and board members indicated their hopes for a moderate rise in rates, defined as one percentage point, or 100 basis points. Of course, those expectations seem quaint today: In 2022, the Federal Reserve increased the federal funds rate’s target range from 0 to 0.25% in the first quarter to 4.25% to 4.5% in December — a more than 400 basis point increase.
A year ago, anyone looking at recent history would have been challenged to foresee this dramatic increase. And looking ahead to 2023, bankers see a precarious future. “We’ve never seen more uncertainty, on so many fronts, across the entire balance sheet,” says Matt Pieniazek, CEO of Darling Consulting Group. “Let clarity drive your thought process and decision-making, not fear.”
While we can’t predict the future, we can leverage the recent past to prepare for what’s ahead. Here are three questions that could help boards and leadership teams plan for tomorrow.
How Will Rising Interest Rates Impact the Bank?
Despite the rapid rise in the federal funds rate, just a handful of banks pay savings rates north of 3%: These include PNC Financial Services Group, which pays 4%; Citizens Financial Group, at 3.75%; and Capital One Financial Corp., at 3.3%. Most still pay the bare minimum to depositors, averaging 0.19% as of Dec. 14, 2022, according to Bankrate.
Pieniazek believes this will change in 2023. “[Banks have] got to accept that they were given a gift [in 2022].” Because of an environment that combined a rapid rise in rates with excess liquidity, banks were able to delay increasing the interest rates paid on deposits.
Funding costs are already beginning to reflect this changing picture, rising from an average 0.16% at the beginning of 2022 to 0.64% in the third quarter, according to the Federal Deposit Insurance Corp.
“The liquidity narrative is changing,” says Pieniazek. “Our models are projecting that there’s going to be substantial catch-up.” Typically, deposits start to get more competitive after a 300 basis point increase in the federal funds rate, he says. We’re well past that.
That means banks need to understand their depositors. Pieniazek recommends breaking these into three groups: the largest accounts, which tend to be the smallest in number and most sensitive to rate changes; stable, mass market accounts with less than $100,000 in deposits; and account holders between these groups, with roughly $100,000 to $750,000 in deposits. Understand the behaviors of each group, and tailor pricing strategies accordingly.
Will Banks Feel the Pain on Credit?
“Most banks are cutting their loan growth outlook in half for 2023, versus 2022,” says Pieniazek. Bank executives and boards should have frank discussions around growth and risk appetites, including loan concentrations. “Are we appropriately pricing for risk? And are we letting blind adherence to competition drive our loan pricing as opposed to stepping back and saying, ‘What is a fair, risk-adjusted return for our bank?,’ and level-set[ting] our loan growth outlook relative to that.”
Steve Williams, president and co-founder of Cornerstone Advisors, sees less weakness in bank balance sheets — credit quality remained pristine in 2022 — and more concern for shadow banks and fintechs that have grown through leveraged, subprime and buy now, pay later loans. If these entities struggle, it could be an opportunity for banks.
“The relationship manager model, in certain segments, has great runway,” says Williams. But that doesn’t mean that banks can simply ignore the disruption that’s already occurred. “We’ve been telling our clients, ‘Don’t dance in the end zone and be cocky,’ because … these blueprints for the future are still there,” he explains. “If we’re going to fight the funding war, we’ve got to do it in modern terms.” That means continuing to invest in technology to deliver better digital services.
How Will the Tech Fallout Impact Banks?
It’s been a rough year for the tech sector. Valuations declined in 2022, according to the research firm CB Insights. Talented employees lost their jobs as tech firms shifted from a growth mindset to a focus on profitability.
“Tech has never been cheaper than it is right now,” says Alex Johnson, creator of the Fintech Takes newsletter. “There [are] ample opportunities to snap up tech companies in a way that there just has never been.”
Many banks aren’t interested in investing in, much less acquiring, a tech company, according to the bank executives and board members responding to Bank Director’s 2023 Bank M&A Survey. Just 15% participated in a fintech-focused venture capital fund in 2021-22; 9% directly invested in a fintech. Even fewer (1%) acquired a technology company during that time, though 16% said it’s a possibility for 2023.
Snatching up laid-off talent could prove more viable for banks: 39% planned to add technology staff in 2022, according to Bank Director’s 2022 Compensation Survey. Many tech workers, scarred by last year’s layoffs, will seek stability. Over the last 10 to 15 years, “tech companies were the most valued place for employees to go; they were paying the highest salaries,” says Johnson. “It’s a huge, almost generational opportunity for banks, when they’re thinking about what their tech strategy is going to be.”
But what about vendors? The number of startups working with banks proliferated over the past few years. Amid this volatility, Johnson advises that banks sort out the “tourists” — opportunistic companies working with banks to demonstrate another avenue for growth — from providers that prioritize working with financial institutions. In today’s tougher fundraising environment, “if you’re a fintech company, you’re basically pulling back from all the things that you don’t think are core to what you do.”
2023 could make crystal clear which tech companies are serious about working with banks.