Focusing on 4 Key Trends for 2023

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The current market presents unique challenges for financial institutions.

As we navigate a complex environment during a time of significant industry change, recessionary pressure and geopolitical uncertainty, it’s crucial that banks focus on a realistic number of strategic priorities. Entering the first quarter of 2023, I see four key trends impacting the financial services industry that boards and executives need to focus on to survive and thrive amid economic uncertainty.

Talent
Having the best bankers, treasury management officers, middle office talent and banking center managers is always critical. But it’s also vitally important to have those unique individuals who can take an innovative idea and turn it into reality.

Your bank needs people who can work well with your partners and vendors to make sure you’re delivering the right kinds of capabilities to customers, and leaders who can see around the corner and anticipate the capabilities you’ll need in the future. That talent can be hard to come by; the turbulent labor market presents some challenges, but also opportunities.

There have already been some significant layoffs at large tech companies, but they aren’t the only ones. Smaller tech companies have also had to cut back — and that could be a chance to hire talent that has historically been out of reach or acquire a superstar that left for an early-stage company and is ready to come back. Lastly, banks should look for high-performing people at lower-performing companies and see if they might be ready for a change. Successful talent strategies will have an outsized impact on future performance.

Strategic Clarity
Reaching strategic clarity with all of your stakeholders will be crucial. Scarce resources and changing investment environments means financial institutions must make clear and deliberate decisions when it comes to their strategies.

Not only is it important to know your customers, your market and how you will differentiate and win, but it’s imperative to guard against strategic drift or succumbing to the temptation to be all things to all customers.

Pressure to Innovate, Simplify
The marketplace has been noisy. The substantial amount of funds invested in new financial technology firms over the past five years has made it feel like there are endless opportunities to innovate. Stakeholders in all directions may be making suggestions and recommendations. This has helped move the banking industry forward in important ways and helped power some of the digital leaps we experienced during the pandemic.

However, bankers seem to gravitate toward complexity. Now is the right time to take a step back, take stock of your organization’s investments and determine whether they have helped you simplify your business and operations.

Could you rethink entire lines of business based on the digital capabilities that you now have? Where can your institution make incremental, but important, moves toward simplification? What are the bank’s most important innovation priorities that need to move forward regardless, or because of, the turbulent macroeconomic environment? These are critical questions that every management team should be addressing.

Deposit Strategy
Not too long ago, it seemed every bank was flush with deposits. Today, even financial institutions with favorable loan-to-deposit ratios are figuring out how their deposit base is changing, what effect higher and rising rates are having, where they’re experiencing attrition and churn within their customer base, and what parts of their funding strategy need to be reworked.

It will be critical to develop a long-term sustainable deposit strategy and identify advantages specific to your institution. For example, in which industries does your bank have lending expertise? Use that experience to develop working capital solutions for those same customers. If your bank has developed your digital banking capabilities, explore where you have untapped potential in the existing customer base with targeted campaigns and marketing messages. Haven’t revisited your compensation strategy? Now is the right time to be addressing incentives for developing a commercial deposits business. Actions that a bank takes today will have a lasting positive impact.

It’s easy for directors and executives to become overwhelmed in such a fluctuating environment but the financial institutions focused on strengthening talent, clarifying critical priorities, accelerating innovation and maximizing their deposit strategies will be ready to take advantage of growth opportunities in this new year.

Deposit Costs Creep Up Following Rate Increases

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The rapidly rising interest rate environment is beginning to impact the funding dynamics at banks as deposit competition increases and they pay up for time deposits.

While rising rates are generally good for lending, the unrelenting climb in interest rates hasn’t been uniformly positive for banks. Since the pandemic, many banks have had historic deposit growth and liquidity. The aggressive and continuous rising interest rate environment could change that. 

There was a 1.1% drop in total deposits at all Federal Deposit Insurance Corp.-chartered banks in the third quarter, according to a November report from analysts at Janney Montgomery Scott. Excluding time deposits like certificates of deposits, or CDs, core deposits dropped 2%. But over that time, 40% of banks reported positive deposit growth in excess of 1%. That could mean that as core deposits leave banks, they are growing time deposits. 

The median cost of deposits for banks in the Kroll Bond Rating Agency universe more than doubled in the third quarter to 37 basis points. 

“No longer content with letting the hot money exit, this sharp increase in deposit costs is the product of a strategy of rate increases designed to stem outflows of less sticky or rate sensitive deposits,” wrote KBRA in a Nov. 15 report.  

One reason for this deposit shift is consumers and businesses are leveraging technology to move their funds into higher rate accounts. Core deposit outflows in future quarters could be unpredictable for institutions: they might happen at a faster pace or higher volume than a bank is prepared for, or a few large, important deposit relationships may leave. This could deplete available cash on hand that an institution would use for ongoing operations or to fund new loan opportunities. 

“The last time we went through a significantly rising rate environment, in the 1970s, money market funds did not exist. People were captive to the bank,” says Nate Tobik, CEO of CompleteBankData and author of “The Bank Investor’s Handbook.” “Now we’re [repeating] the ‘70s, except there are alternatives.”

One option banks had in the past to raise short-term liquidity — selling securities marked as available for sale (AFS) — may be off the table for the time being. The bank space carried a total unrealized loss, mostly tied to bonds, of more than $450 billion in the second quarter, according to the FDIC. This loss is recorded outside of net income, in a call report line item called accumulated other comprehensive income. Selling AFS securities right now would mean the bank needs to record the loss. 

“Over the past couple weeks, we have had multiple discussions with community bankers that have been very focused on deposit generation,” wrote attorney Jeffrey Gerrish, of Gerrish Smith Tuck, in a late October client newsletter. “Unfortunately, many of these community banks have a securities portfolio that is so far under water they really don’t see the ability to sell any securities to generate cash because they cannot afford to take the loss. This is a very common scenario and will result in a pretty healthy competition for deposits over the next 12 to 24 months.”

In response, banks will need to consider other options to raise alternative funds fast. Noncore funding can include brokered CDs, wholesale funding or advances from the Federal Home Loan Banks system. Tobik says CDs appeal to banks because they are relatively easy to raise and are “time deterministic” — the funding is locked for the duration of the certificate. 

All of those products come at a higher rate that could erode the bank’s profit margin. 

Another ratio to watch at this time is the liquidity ratio, wrote Janney analysts in a Nov. 21 report. The liquidity ratio, which compares liquid assets to total liabilities, is used by examiners as a more “holistic” alternative to ratios like loans-to-deposits. The median liquidity ratio for all publicly traded banks at the end of the third quarter was 20%, with most banks falling in a distribution curve ranging from 10% to 25%.

The 20% median is still 4% higher than the median ratio in the fourth quarter of 2019. The effective federal funds rate got as high as 2.4% in summer 2019, compared to 3.08% in October. Janney did find that banks between $1 billion and $10 billion had “relatively lower levels” of liquidity compared to their smaller and bigger peers.

But for now, they see little to worry about, but a lot to keep their eyes on. “Our analysis shows that while liquidity has tightened slightly by several measures since a [fourth quarter 2021] peak, banks still maintain much higher levels of liquidity than prior to the pandemic and have plenty of capacity to take on additional wholesale funding as needed to supplement their core funding bases,” they wrote.

Going forward, banks will need to balance the tension between managing their liquidity profile and keeping their cost of funds low. What is the line between excess liquidity and adequate liquidity? How many deposit relationships need to leave any given bank before it starts a liquidity crunch? What is cost of paying more for existing deposits, versus the potential cost of bringing in wholesale or brokered deposits? 

The answers will be different for every bank, but every bank needs to have these answers.

Banks Are Letting Deposits Run Off, but for How Long?

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In September, the CEO of Fifth Third Bancorp, Tim Spence, said something at the Barclays investor conference that might have seemed astonishing at another time. The Cincinnati, Ohio-based bank was letting $10 billion simply roll off its balance sheet in the first half of the year, an amount the CEO described as “surge” deposits.

In an age when banks are awash in liquidity, many of them are happily waving goodbye to some amount of their deposits, which appear as a liability on the balance sheet, not an asset.
Like Fifth Third, banks overall have been slow to raise interest rates on deposits, feeling no urgency to keep up with the Federal Reserve’s substantial interest rate hikes this year.

Evidence suggests that deposits have begun to leave the banking system. That may not be such a bad thing. But bank management teams should carefully assess their deposit strategies as interest rates rise, ensuring they don’t become complacent after years of near zero interest rates. “Many bankers lack meaningful, what I would call meaningful, game plans,” says Matt Pieniazek, president and CEO of Darling Consulting Group, which advises banks on balance sheet management.

In recent years, that critique hasn’t been an issue — but that could change. As of the week of Oct. 5, deposits in the banking system dipped to $17.77 trillion, down from $18.07 trillion in August, according to the Federal Reserve. Through the first half of the year, mid-sized banks with $10 billion to $60 billion in assets lost 2% to 3% of their deposits, according to Fitch Ratings Associate Director Brian Thies.

This doesn’t worry Fitch Ratings’ Managing Director for the North American banking team, Christopher Wolfe. Banks added about $9.2 trillion in deposits during the last decade, according to FDIC data. Wolfe characterizes these liquidity levels as “historic.”

“So far, we haven’t seen drastic changes in liquidity,” he says.

In other words, there’s still a lot of wiggle room for most banks. Banks can use deposits to fund loan growth, but so far, deposits far exceed loans. Loan-to-deposit ratios have been falling, reaching a historic low in recent years. The 20-year average loan-to-deposit ratio was 81%, according to Fitch Ratings. In the second quarter of 2022, it was 59.26%, according to the Federal Deposit Insurance Corp.

In September, the Federal Reserve’s Board of Governors enacted its third consecutive 75 basis point hike to fight raging inflation — bringing the fed funds target rate range to 3% to 3.25%. Banks showed no signs of matching the aggressive rate hikes. The median deposit betas, a figure that shows how sensitive banks are to rising rates, came in at 2% through June of this year, according to Thies. That’s a good thing: The longer banks can hold off on raising deposit rates while variable rate loans rise, the more profitable they become.

But competitors to traditional brick-and-mortar banks, such as online banks and broker-dealers, have been raising rates to attract deposits, Pieniazek says. Many depositors also have figured out they can get a short-term Treasury bill with a yield of about 4%. “You’re starting to see broker-dealers and money management firms … promot[e] insured CDs with 4% [rates],” he says. “The delta between what banks are paying on deposits and what’s available in the market is the widest in modern banking history.”

The question for management teams is how long will this trend last? The industry has enjoyed a steady increase in noninterest-bearing deposits over the years, which has allowed them to lower their overall funding costs. In the fourth quarter of 2019, just 13.7% of deposits were noninterest bearing; that rose to 25.8% in the second quarter of 2021, according to Fitch. There’s a certain amount of money sitting in bank coffers that hasn’t left to chase higher-yielding investments because few alternatives existed. How much of that money could leave the bank’s coffers, and when?

Pieniazek encourages bank boards and management teams to discuss how much in deposits the bank is willing to lose. And if the bank starts to see more loss than that, what’s Plan B? These aren’t easy questions to answer. “Why would you want to fly blind and see what happens?” Pieniazek asks.

What sort of deposits is the bank willing to lose? What’s the strategy for keeping core deposits, the industry term for “sticky” money that likely won’t leave the bank chasing rates? Pieniazek suggests analyzing past data to see what happened when interest rates rose and making some predictions based on that. How long will the excess liquidity stick around? Will it be a few months? A few years? He also suggests keeping track of important, large deposit relationships and deciding in what circumstances the bank will raise rates to keep those funds. And what should tellers and other bank employees say when customers start demanding higher rates?

For its part, Fifth Third has been working hard in recent years to ensure it has a solid base of core deposits and a disciplined pricing strategy that will keep rising rates from leading to drastically higher funding costs. It’s been a long time since banking has been in this predicament. It’s anyone’s guess what happens next.

Student Loans Come Due

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Just as the Federal Reserve raises rates and inflation hits a 40-year high, Americans with federal student loan debt will start making payments on the debt after a two-year pause. On Aug. 31, the Department of Education will require 41 million people with student loans to begin paying again. 

According to the Federal Reserve, about one in five Americans have federal student loan debt and they saved $5 billion per month from the forbearance. It’s safe to say that a lot of people are going to struggle to restart those payments again and some of them work for banks.

The good news is that there are new employee programs that can help. One CARES Act provision allowed companies to pay up to $5,250 toward an employee’s student loans without a negative tax hit for the employee. Ally Financial, Fidelity Investments, SoFi Technologies, and First Republic Bank are a few of the many financial companies offering this benefit to employees. First Republic launched its program in 2016, after its purchase of the fintech Gradifi, which helps employers repay their employees’ loans. These programs typically pay between $100 and $200 a month on an employee’s loans, and usually have a cap.

The 2020 Bank Director Compensation Survey shows that 29% of financial institutions offered student loan repayment assistance to some or all employees. Many of those programs discontinued when the student forgiveness program started. In the anticipation of government forbearance coming to a close, now is a good time to think about restarting your program or even developing one. 

Americans now hold $1.59 trillion in student loan debt, according to the Federal Reserve. How did we get here? College got more expensive— much more expensive. 

Earlier this summer, the Federal Reserve and Aspen Institute had a joint summit to discuss household debt and its chilling effect on wealth building. The average cost of college tuition and fees at public 4-year institutions has risen 179.2% over the last 20 years for an average annual increase of 9.0%, according to EducationData.org.

At the same time, wages have not shown much inflation-adjusted growth. ProPublica found in 2018 that the real average wage of workers, after accounting for inflation, has about the same purchasing power it did 40 years ago. And inflation in 2022 has far outpaced wage increases. Some economists speculate that any pandemic-era wage increases are effectively nullified by this rapid inflation.

Not all borrowers are equally impacted. Sixteen percent of graduates will have a debt-to-income ratio of over 20% from their student loans alone, according to the website lendedu.com, while another 28% will have a DTI of over 15%. The 44% of graduates with that level of debt exiting school will face a steep climb to meaningful wealth building. The students that didn’t graduate will have an even harder climb.

Those graduates who struggle with their student loans will be less likely to buy a home or more likely to delay home ownership. They will be less likely to take on business debt or save for retirement. Housing prices have risen in tandem with education prices. The “starter home” of generations past has become unattainable to many millennial and Gen Z debt holders.

More than half of borrowers owe $20,000 or less. Seven percent of people with federal debt owe more than $100,000, according to The Washington Post. Economists at the Federal Reserve say borrowers with the least amount of debt often have difficulty repaying their loans, especially if they didn’t finish their degree. Conversely, people with the highest loan balances are often current on their payments. It’s likely that people with higher loan debt generally have higher education levels and incomes.

The Aspen Institute published a book known as “The Future of Building Wealth: Brief Essays on the Best Ideas to Build Wealth — for Everyone,” in conjunction with the Federal Reserve Bank of St. Louis. It illuminates long-term solutions for financial planning, focusing on policies and programs that could be applied at a national scale. 

In the absence of these national solutions, some employers are taking the matter into their own hands with company policies designed to help employees with student debt. Those banks are making a difference for their own employees and are part of the solution. 

Inflation, Interest Rates and ‘Inevitable’ Recession Complicate Risks

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What is the bigger risk to banks: inflation, or the steps the Federal Reserve is taking to bring it to heel?

Community banks are buffeted by an increasingly complicated operating environment, said speakers at Bank Director’s 2022 Bank Audit and Risk Committees Conference in Chicago, held June 13 to 15. In rather fortuitous timing, the conference occurred in advance of the Federal Reserve’s Federal Open Market Committee’s June meeting, where expectations were high for another potential increase in the federal funds rate. 

On one hand, inflation remains high. On the other hand, rapidly increasing interest rates aimed at interrupting inflation are also increasing risk for banks — and could eventually put the economy into a tailspin. Accordingly, interest rates and the potential for a recession were the biggest issues that could impact banks over the next 12 to 18 months, according to a pop up poll of some 250 people attending the event.  

Brandon Koeser, a financial services senior analyst at audit and consulting firm RSM US, said that inflation is the “premier risk” to the economic outlook right now. He called the consumer price index trend line “astonishing” — and its upward path may still have some momentum, given persistently high energy prices. Just days prior, on June 10, the Bureau of Labor Statistics announced that the CPI increased 1% in May, to 8.6% over the last 12 months. 

Koeser also pointed out that inflation is morphing, broadening from goods into services. That “rotation” creates a stickiness in the market that will be harder for the Federal Reserve to fight, increasing the odds that inflation persists.

It is “paramount” that the economy regain some semblance of price stability, Koeser said. In response, central bankers are increasing the pace, and potential size, of federal fund rate increases. But jacking up rates to lower prices without causing a recession is a blunt approach akin to “trying to thread a needle wearing boxing gloves,” he said.

While higher interest rates are generally good for banks, an inflationary environment could dampen loan growth while intensifying interest rate and credit risk, according to the Federal Deposit Insurance Corp.’s 2022 Risk Review. Inflation could lead consumers to cut back on spending, leading to lower business sales, and it could make it harder for borrowers to afford their payments.

At the same time, banks awash in pandemic liquidity added longer-term assets in 2021 in an attempt to capture some yield. Assets with maturities that were longer than three years made up 39% of assets at banks in 2021, compared with 36% in 2019, according to the FDIC. Community banks were even more vulnerable. Longer-term assets made up 52% of total assets at community banks at the end of 2021.

Managing this interest rate risk could be a challenge for banks that lack institutional knowledge of this unique environment. Kyle Manny, a partner at audit and consulting firm Plante Moran, pointed out that many banks are staffed with individuals who weren’t working in the industry in the 1980s or prior. He shared an anecdote of a seasoned banker who admitted he was “caught flat footed” by taking too much risk on the yield curve in the securities portfolio, and was now paying the price after the fair value of those assets fell. 

And high enough rates may ultimately send the economy into a recession. In Koeser’s poll of the audience, about 34% of audience members believe a recession will occur within the next six months; another 36% saw one as likely occurring in the next six to 12 months. Koeser said he doesn’t think it’s “impossible” for the central bank to avert a recession with a soft landing — but the margin for error is getting so small that a downturn may be “inevitable.”

Banks have limited options in the face of such macroeconomic trends, but they can still manage their own credit risk. David Ruffin, principal at credit risk analytics firm IntelliCredit, a division of Qwickrate, said that credit metrics today are the most “pristine” he had seen in his nearly 50 years in the industry. Still, the impact of the coronavirus pandemic and inflation could hide emerging credit risk on community bank portfolios. Kamal Mustafa, chairman of the strategic advisory firm Invictus Group, advised bankers to dig into their loan categories, industry by industry, to analyze how different borrowers will be impacted by these countervailing forces. Not all businesses in a specific industry will be impacted equally, he said.

So while banks can’t control the environment, they can at least understand their own loan books. 

The Key To Creating A Profitable Deposit Strategy

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deposit-5-6-19.pngSmall and mid-size banks can leverage technology to retain and grow their retail relationships in the face of fierce competition for deposits.

Big banks like JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. continue to lead the battle for deposits. They grew their domestic deposits by more than 180 percent, or $2.4 trillion, over the past 10 years, according to an analysis of regulatory data by The Wall Street Journal. To survive and thrive, smaller institutions will need to craft sustainable, profitable strategies to grow deposits. They should invest in technology to become more efficient, develop effective marketing strategies and leverage data and analytics to personalize products and customer experiences.

Banks can use technology to achieve efficiencies such as differentiating net new money from transfers of existing funds. This is key to growing deposits. Traditionally, banks and their legacy core systems were unable to distinguish between new deposits and existing ones. This meant that banks paid out promotional interest and rewards to customers who simply shifted money between accounts rather than made new deposits. Identifying net new money allows banks to offer promotions on qualified funds, govern it more effectively, incentivize new termed deposits and operate more efficiently.

To remain competitive, small and mid-sized banks should leverage technology to create experiences that strengthen customer retention and loyalty. One way they can do this is through micro-segmentation, which uses data to identify the interests of specific consumers to influence their behavior. Banks can use it to develop marketing campaigns that maximize the effectiveness of customer touchpoints.

Banks can then use personalization to execute on these micro-segmentation strategies. Personalized client offerings require data, a resource readily available to banks. Institutions can use data to develop a deeper understanding of consumer behaviors and personalize product offers that drive customer engagement and loyalty.

Consumers deeply valued personalization, making it critical for banks trying to attract new customers and retain existing ones. A report by The Boston Consulting Group found that 54 percent of new bank customers said a personalized experience was “either the most important or a very important factor” in their decision to move to that bank. Sixty-eight percent of survey respondents added products or services because of a personalized approach. And “among customers who had left a bank, 41 percent said that insufficient personalized treatment was a factor in their decision,” the report read.

Banks can use data and analytics to better understand consumer behavior and act on it. They can also use personalization to shift from push marketing that promotes specific products to customers to pull marketing, which draws customers to product offerings. Institutions can leverage relationship data to build attractive product bundles and targeted incentives that appeal to specific customer interests. Banks can also use technology to evaluate the effectiveness of new products and promotions, and develop marketing campaigns to cross sell specific, recommended products. This translates to more-informed offers with greater response, leading to happier customers and improved bottom lines.

Small and mid-sized banks can use micro-segmentation and personalization to increase revenue, decrease costs and provide the kind of customer experience that wins customer deposits. Building and retaining relationships in the digital era is not easy. But banks can use technology to develop marketing campaigns and personalization strategies as a way to strengthen customer loyalty and engagement.

As the competition for deposits heats up, banks will need to control deposits costs, prevent attrition and grow deposits in a profitable and sustainable way. Small and mid-size banks will need to invest in technology to optimize marketing, personalization and operational strategies so they can defend and grow their deposit balances.

The Flawed Argument Against Community Banks

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deposit-4-5-19.pngA few weeks ago, The Wall Street Journal published a story that struck a nerve with community bankers.

The story traced the travails of National Bank of Delaware County, or NBDC, a $375 million asset bank based in Walton, New York, that ran into problems after buying six branches from Bank of America Corp. in 2014.

It’s not that things were going great for NBDC prior to that, because they weren’t. Like many banks in small towns, it had to contend with stiff economic and demographic headwinds.

“As in other small towns that were once vibrant, decades of economic change altered the fabric of Walton,” Rachel Louise Ensign and Coulter Jones wrote in the Journal. “The number of area farms dwindled and manufacturing jobs disappeared.”

“Being located in, and serving, an economically struggling community could bring any bank down,” wrote Ron Shevlin, director of research at Cornerstone Advisors, in a follow-up story a week later.

NBDC hoped the branches acquired from Bank of America, for a combined $1 million, would revive its fortunes. But the deal only made things worse.

The branches saddled NBDC with higher costs and $12 million in added debt. Even worse, half the acquired deposits quickly went elsewhere, provoked by a poorly executed integration as well as, ostensibly, NBDC’s antiquated technology.

“Technology is causing strains throughout the banking industry, especially among smaller rural banks that are struggling to fund the ballooning tab,” Ensign and Jones wrote. “Consumers expect digital services including depositing checks and sending money to friends, which means they don’t necessarily need a local branch nearby. This increasingly means people are choosing a big bank over a small one.”

This echoes a common refrain in banking: that smaller regional and community banks can’t compete against the multibillion-dollar technology budgets of big banks—especially JPMorgan Chase & Co., Bank of America and Wells Fargo & Co.

Community bankers took issue with the article, Shevlin noted, because it seemed to portray the story of NBDC, which was acquired in 2016 by Norwood Financial Corp., as representative of community banks more broadly.

“This is so misleading,” tweeted Andy Schornack, president of Security Bank & Trust in Glencoe, Minnesota. “Pick on one under-performing bank to represent the whole.”

“Community banks are profitable and thriving,” tweeted Tanya Duncan, senior vice president of the Massachusetts Bankers Association. “Most offer technology that makes transactions seamless.”

Schornack and Duncan are right. One doesn’t have to look far to find community banks that are thriving, with many outperforming the industry.

A textbook example is Germantown Trust and Savings Bank, a $376 million asset bank based in Breese, Illinois.

Germantown has generated a higher return on assets than the industry average in 11 of the past 12 years. The only exception was in 2013, when it generated a 1.52 percent pre-tax ROA, compared to 1.55 for the overall industry.

 Germantown-Bank-chart.png

Germantown’s performance through the financial crisis was especially impressive. While most banks reported lower earnings in 2009, with the typical bank recording a loss, Germantown experienced a surge in profitability.

Germantown has gained local market share, too. Over the past eight years, its share of deposits throughout its four-branch footprint in Clinton County, Illinois, has grown from 27.8 percent up to 29.7 percent.

This is just one example among many community banks with a similar experience. For every community bank that’s ailing, in other words, you could point to one that’s thriving.

Yet, there’s another, more fundamental issue with the prevailing narrative in banking today. Namely, the data doesn’t support the claim that the biggest and most technologically-savvy banks are gobbling up share of the national deposit market. Twitter_Logo_Blue.png

In fact, just the opposite has been true over the past five years.

Let’s start with the big three retail banks—JPMorgan Chase, Bank of America and Wells Fargo—which are spending tens of billions of dollars a year on technology.

These three banks saw their combined share of domestic deposits swell in the wake of the financial crisis, climbing from 21.7 percent in 2007 up to 33.2 percent six years later. Since 2013, however, this trend has gone in the opposite direction, falling in four of the past five years. As of 2018, the three biggest banks in the country controlled 31.8 percent of total domestic deposits, a decline of 1.4 percentage points from their peak.

 Deposit-share-chart.png

The same is true if you broaden this out to include the nine biggest commercial banks. Their combined share of domestic deposits has dropped from a high of 47.6 percent in 2013 down to 45.6 percent last year.

Given the number of branches many of these banks have shed over the past decade, it’s surprising they haven’t lost a larger share of domestic deposits. Nevertheless, it’s worth reflecting on the fact that, despite the gloomy sentiment toward community banks that’s often parroted in the press, their current and future fortunes are far from bleak.

This Bank Is Winning the Competition for Deposits

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deposits-3-15-19.pngFrom the perspective of a community or regional bank, one of the most ominious trends in the industry right now is the organic deposit growth at the nation’s biggest banks.

This trend has gotten a lot of attention in recent years. Yet, the closer you look, the less ominous it seems—so long as you’re not a community or regional bank based in a big city, that is.

The experience of JPMorgan Chase & Co. serves as a case in point.

Deposits at Chase have grown an average of 9.4 percent per year since 2014. That’s more than twice the 4.6 percent average annual rate for the rest of the industry. Even other large national banks have only increased their deposits by a comparatively modest 5.3 percent over this period.

This performance ranks Chase first in the industry in terms of the absolute increase in deposits since 2014—they’re up by a total of $215 billion, which is equivalent to the seventh largest commercial bank in the country.

If any bank is winning the competition for deposits, in other words, it seems fair to say it’s Chase.

But why is it winning?

The answer may surprise you.

It certainly helps that Chase spends billions of dollars every year to be at the forefront of the digital banking revolution. Thanks to these investments, it has the single largest, and fastest growing, active mobile banking base among U.S. banks.

As of the end of 2018, Chase had 49 million active digital customers, 33 million of which actively use its mobile app. Eighty percent of transactions at the bank are now completed through self-service channels, yielding a 15-percent decline in the cost to serve each consumer household.

Yet, even though digitally engaged customers are more satisfied with their experience at Chase, spend more money on Chase-issued cards and use more Chase products, its digital banking channels aren’t the primary source of the bank’s deposit growth.

Believe it or not, Chase attributes 70 percent of the increase in deposits to customers who use its branches.

“Our physical network has been critical in achieving industry-leading deposit growth,” said Thasunda Duckett, CEO of consumer banking, at the bank’s investor day last month. “The progress we’ve made in digital has made it easier for our customers to self-serve. And we’ve seen this shift happen gradually across all age groups. But even as customers continue to use their mobile app more often, they still value our branches. Convenient branch locations are still the top factor for customers when choosing their bank.”

This bears repeating. Despite all the hoopla about digital banking—much of which is legitimate, of course—physical branches continue to be a primary draw of deposits.

Suffice it to say, this is why Chase announced in 2018 that it plans to open as many as 400 new branches in major cities across the East Coast and Mid-Atlantic regions.

Three of Chase’s flagship expansion markets are Boston, Philadelphia and Washington, D.C. This matters because large metropolitan markets like these have performed much better in the ongoing economic expansion compared to their smaller, nonmetropolitan counterparts.

The divergence in economic fortunes is surprising. A full 99 percent of population growth in the country since 2007 has occurred in the 383 urban markets the federal government classifies as metropolitan areas. It stands to reason, in turn, that this is where deposit growth is occurring as well.

Chase isn’t the only big bank expanding in, and into, large metropolitan markets, either. Bank of America Corp. is doing so, too, recently establishing for the first time a physical retail presence in Denver. And U.S. Bancorp and PNC Financial Services Group are following suit, expanding into new retail markets like Dallas.

The point being, even though the trend in deposit growth has led analysts and commentators to ring the death knell for smaller community and regional banks without billion-dollar technology budgets, there’s reason to believe that the business model of many of these banks—focused on branches in smaller urban and rural areas—will allow them to continue prospering.

It’s ‘Game On’ in the Battle for Bank Deposits

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deposits-2-13-19.pngAs both interest rates and loan demand rise, the battle for deposits among community financial institutions is only getting tougher.

Following the financial crisis, consumers generally parked their money in banks across the U.S. Despite the little or no interest these institutions offered, deposits grew steadily—to historic levels, in fact.

After multiple interest rate hikes and a burgeoning economy, depositors now more often shop for higher yields. According to third quarter 2018 Federal Deposit Insurance Corp. data, noninterest-bearing deposits declined by $72.9 billion (2.3 percent), the largest quarterly dollar decline since the first quarter of 2013.

This shift is concerning for community banks because deposits help fund loans and serve as a key factor in determining overall profitability. As a result, community bank management teams must develop strong deposit strategies that ensure future growth and institutional stability.

Loan Funding and Deposits
Community institutions must seek more expensive funding—which shrinks profitability—or even decrease lending. The latter strategy is not what most banks want to do, especially since loan demand has generally been improving.

Fifty-five percent of bankers reported an increase in loan demand over the past 12 months, up two percentage points from the previous quarter, according to Promontory Interfinancial Network’s Bank Executive Business Survey, published in the third quarter of 2018. A recent survey conducted by JPMorgan Chase & Co. found about 91 percent of small and midsize companies expect to maintain or increase capital expenditures in 2019.

This scenario brings new attention and importance to loan-to-deposit ratio (LDR), a ratio of total outstanding loans to its total deposit balance. Traditionally, banks try to maintain an LDR around 80–90 percent, to maintain adequate liquidity.

Beating the Competition
Promontory’s study states that 90 percent of 389 bank CEOs, presidents and CFOs that were surveyed across all asset sizes and regions expect to see an increase in deposit competition over the next 12 months.

Growing deposits is especially important for regional and community banks that lack the branch networks, digital footprints and marketing budgets of the nation’s largest institutions, which have experienced above-average deposit growth.

Promontory also asked what strategies they are using to increase deposits. The majority said offering higher interest rates is the best strategy.

While many institutions hold off on interest rate increases as long as possible, it may be time to consider this strategy. But with so many banks also raising rates, other efforts to create differentiation in the marketplace is essential, including:

Target growth in specific deposit products, including commercial deposits, treasury management activities and retail time deposits.

  • Consider employing time deposit sales strategies, including training frontline staff to negotiate tailored CD rates and terms.

Employ client-focused approaches not dependent on rate, like enhanced customer service and establishing stronger relationships with depositors.

  • Capitalize on the bank’s data to personalize the consumer journey across all channels and touchpoints, including account onboarding. McKinsey estimates personalization can deliver 5 to 8 times the return on investment in marketing expenditures, and can lift sales by 10 percent or more. 
  • Emulate the service standards set by Amazon and Google, which personalize, predict and suggest a next purchase.
  • Provide tailored financial education based on individual goals and cross-sell based on current product penetration. 

Invest in a digital referral program. Your current customers are your best source for profitable checking account growth. Using digital word-of-mouth referral programs on phones, tablets, computers and social media is key to brand awareness and recommendations.

  • According to the EY’s Global Consumer Banking Survey, 71 percent of global consumers consult friends, families and colleagues first about banking products and relationships.

Improve marketing and advertising efforts

  • Banks can use automated marketing platforms, local search engine optimization (SEO), geo-targeting, social media, mobile technology, etc. 

Capitalize on reciprocal deposits, which are no longer considered brokered deposits thanks to the Economic Growth, Regulatory Relief, and Consumer Protection Act, signed into law in May 2018. In a nutshell, the new law can make it possible for qualifying banks to more readily tap stable, mostly local funds while reducing the risk for customers to deposit more than $250,000.

Invest in cost-effective digital and cloud-computing technology that delivers faster, more transparent and smoother access to services.

  • These technologies include digital lending for consumers and small businesses, online account opening and onboarding, user-friendly apps, mobile payments, biometrics, contactless ATMs, etc.

Today’s bank customers want to maximize return on their deposits and banking relationship. For community banks, collecting and keeping these deposits is a strategic objective that may not be achieved with a lone “silver bullet” tactic. Absent a merger/acquisition proposition, these institutions are wise to adopt a proactive, multi-pronged approach.

A New View for Deposit Strategies

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As rates continue to rise, now is the time for bank boards and management teams to consider deposit strategies for the future. In this video, Barbara Rehm of Promontory Interfinancial Network sits down with H.D. Barkett, senior managing director at Promontory Interfinancial Network, who shares his thoughts on what banks should consider in today’s environment.

Barkett discusses:

  • Balance Sheet Advice for Today’s Banks
  • Impact of Regulatory Relief on Reciprocal Deposits

For more information about the reciprocal deposits provision in the Economic Growth, Regulatory Relief and Consumer Protection Act, please visit Promontory Interfinancial Network by clicking here.