Mobile Banking Attracts Deposits; Does It Aid Their Exit?

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Mobile banking channels, which banks have used to attract deposits, are helping deposits flow out faster as rates rise, a May research paper shows. 

The combination of higher interest rates and technology means that banks with robust mobile banking capabilities have also seen more deposit runoffs — even before the spring banking crisis — according to researchers from Columbia University, the University of Chicago and the National Bureau of Economic Research.  

They found that mobile banking has increased the sensitivity of deposits to interest rates, reducing their stickiness: it’s easier for customers to shop rates, open accounts and move funds. The paper refers to the slow or gradual pace of deposits leaving banks as “deposit walks” versus deposit runs, where many customers overwhelm a bank with withdrawal requests.

“Average deposits have become more sensitive to changes in the federal funds rate in the last decade,” they found. This is “particularly pronounced for banks with a digital platform and banks with a brokerage account.” 

In the study, banks were considered digital if their mobile application had at least 300 reviews, and as having brokerages if they report brokerage income in their call report. In the study, 64% of banks that had between $1 billion and $250 billion in assets — admittedly a wide swath — were considered digital. The impact of digital bank channels on deposits appeared in third quarter 2022 as deposit growth between digital and nondigital banks diverged; a quarter later, digital banks began losing both insured and uninsured deposits. 

“Whatever happened in the banking system in late 2022 and early 2023 was not just about the flight of uninsured deposits,” they wrote.

A 400 basis points increase in the federal funds rate leads to deposit decline of 6.4% at banks that don’t have a brokerage and aren’t considered digital, compared to 11.6% for digital banks with a brokerage. They also found that digital banks slowed their “deposit walks” by increasing deposit rates and their overall deposit betas.

Although larger banks with brokerages certainly could have more rate-sensitive customers than smaller banks without brokerages, the researchers attempted to account for that adding another analysis: internet usage among depositors. 

“We find that banks’ deposit outflows are more pronounced in markets with higher internet usage, but that this is only the case for digital banks (regardless of whether they report brokerage fees or not),” the researchers wrote.

Digital banking capabilities contributed to the rapid failure of Silicon Valley Bank, Signature Bank and First Republic Bank, according to testimony from bank officials and regulators. Silicon Valley Bank customers “sought to withdraw nearly all” of the bank’s deposits in less than 24 hours, said Federal Deposit Insurance Corp. Chair Martin Gruenberg in May 18 testimony to the U.S. Senate. He added that “the ease and speed of moving deposits to other deposit accounts or non-deposit alternatives with the widespread adoption of mobile banking” is a development that has increased the banking industry’s “exposure to deposit runs.”

First Republic Bank’s run was “exacerbated” in part by “recent technological advancements that allow depositors to withdraw their money almost immediately,” said former First Republic Bank CEO Michael Roffler in May 17 Congressional testimony. The bank experienced $40 billion in deposit outflows on March 13, after the failures of Silicon Valley and Signature, and a total of $100 billion in withdrawals in the ensuing weeks. 

Not everyone is concerned about the impact of mobile apps on deposits and its implications on bank stability. Ron Shevlin, managing director and chief research officer of Cornerstone Advisors, believes that a small percentage of banks will face notable deposit exits, with most banks able to keep funds stable. Additionally, he points out that banks benefited from having digital and mobile banking channels, especially in the earliest days on the coronavirus pandemic. 

“I don’t think it’s that big of a problem because I think a lot of financial institutions are fairly sophisticated in looking at this,” he says. Banks aren’t just looking at account closures to study deposit outflows; they also analyzing changes in account behavior and transactions. “This is not super new behavior anymore. It’s been in the making for 15 to 20 years.”

Both Shevlin and Luigi Zingales, one of the authors on the paper and a professor at the University of Chicago Booth School of Business, see digital transformation as an inevitability for banks. Zingales points out that apps — not branches — will shape the next generation’s experience with banks. As more community banks become digital banks, he says they may need to adjust their assumptions and expectations for how these capabilities could alter their deposit base, costs and overall balance sheet.

“I think what you need to do is be much more vigilant in how you invest your assets. In the past, you had this natural edge and now this natural edge is much smaller. And if you think you have this natural edge and you take a lot of duration risk, you get creamed,” he says. “I think the [solution] is not to resist technology — to some extent, it’s irresistible. The [solution] is learning to live with a new technology and understanding that the world has changed.”

Risk issues like these will be covered during Bank Director’s Bank Audit & Risk Conference in Chicago June 12-14, 2023.

What Silicon Valley Bank’s Failure Means for Incentive Compensation

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The day Silicon Valley Bank failed on March 10, the bank paid out millions in bonuses to senior executives for its 2022 performance, according to the Federal Reserve’s April postmortem analysis and the bank’s proxy statement. Those bonuses were paid despite ongoing regulatory issues, including a May 2022 enforcement action.

As details trickle out about Silicon Valley Bank’s and Signature Bank’s failures, it’s becoming clear that regulators are interested in greater regulation and scrutiny of incentive plans. 

Among key risk management gaps, Federal Reserve Vice Chair for Supervision Michael Barr found fault in Silicon Valley Bank’s board compensation committee, noting that holding company SVB Financial Group’s “senior management responded to the incentives approved by the board of directors; they were not compensated to manage the bank’s risk, and they did not do so effectively.” Further, he wrote in the Fed’s April report: “We should consider setting tougher minimum standards for incentive compensation programs and ensure banks comply with the standards we already have.” 

It’s likely that supervisors will revisit examinations for banks between $50 billion and $250 billion in assets, which received regulatory relief following the 2018 rollback, says Todd Leone, a partner at the compensation firm McLagan. But supervisors recognized deficiencies in SVB’s incentive compensation governance prior to its failure, Barr revealed. Changes — via legislation and enhanced supervision — may occur, along with the finalization of incentive compensation and clawback rules coming out of the 2010 Dodd-Frank Act. 

Following the failures of Silicon Valley Bank and Signature Bank, lawmakers including U.S. Sen. Gary Peters, D-Mich., urged regulators to finalize Section 956 of Dodd-Frank, which requires regulators to issue rules for institutions above $1 billion in assets around the prohibition of excessive incentive compensation arrangements that encourage inappropriate risks, and mandate disclosure of incentive compensation plans to a bank’s federal regulator. Leone says that the rule was proposed with credit risk in mind, but its application could be expanded to consider liquidity.

The agencies tasked with this joint rulemaking, which include the Federal Deposit Insurance Corp., Federal Reserve, and the U.S. Securities and Exchange Commission, issued a request for comment on a proposed rule in 2016.

For public banks, the SEC finally released its clawback rule tied to Dodd-Frank in 2022. Put simply, the rule will require public companies to adopt policies that allow for the recovery of compensation in certain scenarios, including earnings restatements. The policy must be disclosed. Troutman Pepper expects that companies will have to comply as early as August. Gregory Parisi, a partner at the law firm, believes additional scrutiny on clawback policies will trickle down through the industry to smaller banks.

Clawback policies should cover numerous scenarios. “If the only triggers you have are tied to financial restatements, then it’s probably not broad enough,” says Daniel Rodda, a partner at Meridian Compensation Partners.

U.S. Sen. Elizabeth Warren, D-Mass., and U.S. Rep. Josh Hawley, R-Mo., introduced legislation on March 29 that would authorize the FDIC to claw back compensation when a bank fails.

Beyond the Dodd-Frank rules, banks should consider how to strengthen their governance practices to better tie compensation to risk. “… Incentive compensation arrangements should be compatible with effective risk management and controls,” wrote Barr in April, citing the 2010 Interagency Guidance on Sound Incentive Compensation Policies. Those arrangements “should be supported by strong corporate governance practices, including active and effective oversight by boards of directors,” he added.

Barr also pointed out that SVB’s compensation committee didn’t receive performance evaluation materials from CEO Greg Becker, relying instead on his recommendations. 

“There can be times where [the board relies] on a verbal discussion around performance with the CEO,” says Rodda, “but having it documented in the materials and making sure that those performance evaluation materials include commentary from risk as part of the performance evaluation, those are certainly good processes to have in place.”

SVB said risk management was a “key component of compensation decisions” in its proxy statement filed on March 3, just days before the bank’s failure, but listed return on equity, total shareholder return and stock price appreciation as specific measurements for 2022 incentive payments. 

Rodda recommends that boards consider a combination of metrics that include capital ratios and risk-adjusted returns — not just profitability and growth — and incorporate qualitative approaches that could consider feedback from regulators and an overall view of risk management.

On May 31, 2022, supervisors flagged SVB’s incentive compensation process as a Matter Requiring Immediate Attention (MRIA) by the board, ordering the compensation committee to develop “mechanisms to hold senior management accountable for meeting risk management expectations.” SVB’s compensation committee was in the process of changing its incentive structure and approved bonuses in January 2023 that were paid out in March despite the bank’s dramatic deposit loss, according to the Barr report. 

“There should be a structured opportunity within the incentive program to evaluate the effectiveness of risk management,” says Rodda. “And if there are items that have been flagged by the regulators as critical and indicate that risk is not being managed well, then the committee should use its judgment to impact payouts based on that.”

Compensation issues like these will be covered during Bank Director’s Bank Board Training Forum in Nashville, Sept. 11-12, 2023.

This article was updated to correct a reference to Section 956.

Lessons Gleaned From Bank Failures

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The postmortem regulatory reports on the failures of $209 billion Silicon Valley Bank and $110 billion Signature Bank are an emphatic reminder of the consequences of poor risk management.

Among the specific circumstances that contributed to their closures in spring 2023 is how their boards and management teams failed to effectively manage several core banking risks, including interest rate, liquidity and growth, according to reports from the Federal Reserve and the Federal Deposit Insurance Corp. The official reports confirm recent media reporting that indicated surprisingly lax risk management practices at the banks, both of which were some of the largest in the country. Community banks that may see themselves as having little in common with these large institutions can still glean insights from the reports — and perhaps, avoid their fates.

Santa Clara, California-based Silicon Valley Bank’s “rapid failure can be linked directly to its governance, liquidity, and interest rate risk-management deficiencies,” the Fed wrote. And the FDIC found that New York-based Signature Bank had weaknesses in “liquidity contingency planning, liquidity stress testing, and internal controls” that figured “prominently” in its failure.

Interest Rate Risk
“While interest rate risk is a core risk of banking that is not new to banks …, SVB did not appropriately manage its interest rate risk,” the Fed wrote. 

The bank’s interest rate risk (IRR) policy — which detailed how the bank would manage and measure interest rate risk — was vague. It didn’t specify which scenarios to run, how to analyze assumptions, how to conduct sensitivity analysis and it didn’t define back-testing requirements. The bank used “the most basic” IRR measurement available, despite its size.

Still, its models indicated the bank had a structural mismatch between repricing assets and deposit liabilities; as early as 2017, it identified breaches in its long-term IRR limits, the Fed wrote. But instead of addressing the “structural mismatch” between longer duration bonds and demand deposits, the bank adjusted its model to get better results.

“I lose count of the number of cognitive biases that got activated in their process — from confirmation bias and optimism bias to so much else,” says Peter Conti-Brown, an associate professor of financial regulation at The Wharton School at the University of Pennsylvania. “It is the most common story ever told: When you make big goals, you then try to rough up the ref so that you can get the outcomes you’re seeking. The ref in this case is basic bank accounting.” 

Additionally, Silicon Valley executives also removed interest rate hedges that would’ve protected it from rising rates, a move the Fed attributes to maintaining short-term profits instead of managing the balance sheet. 

“That’s more casino behavior than it is prudential behavior,” says Joe Brusuelas, chief economist at RSM US LLP. “It’s throwing the dice at a casino.”

Liquidity Risk
Both banks had an unusually large percentage of accounts that were over the $250,000 deposit insurance threshold, the withdrawals of which acutely contributed to their failures. 

“Uninsured deposits are considered higher risk as they are more prone to rapid runoff during reputational or financial stress than insured deposits,” the FDIC wrote. But Signature’s management didn’t develop a funds management policy or a contingency plan, in part because they didn’t believe those customer deposits would become volatile. 

“[Signature’s p]resident rejected examiner concerns about the stability of uninsured deposits as late as noon EST on March 10, 2023,” the FDIC wrote. New York regulators closed the bank on March 12. “[M]anagement’s lack of a well-documented and thoroughly tested liquidity contingency plan and its lack of preparedness for an unanticipated liquidity event were the root cause of the bank’s failure.”

Both management teams had assumptions around their deposit base that “just weren’t true” Brusuelas says. He adds that bank management teams now should reexamine their analytical framework around their liquidity risk management and strengthen governance policies and limits around their deposit mix.

The FDIC wrote that funds management practices should lay out how a bank will maintain sufficient liquidity levels, how it will manage unplanned or unanticipated changes in funding sources — like a number of large accounts withdrawing and how it will react and withstand changes in market conditions. The practices should also incorporate the costs of the backup liquidity or source of the liquidity, both of which may change under market stress.

Backup liquidity is crucial in times of stress. Silicon Valley Bank didn’t test its capacity to borrow at the Federal Reserve’s discount window in 2022; when the run started, it didn’t have appropriate collateral and operational arrangements in place to meet its obligations. 

Growth
“The fundamental risk of too much growth too fast is a failure of diversification,” Conti-Brown says. “Rapid growth comes [from] a sudden influx of funding … that goes into a small number of asset classes.” 

Both reports discuss how already-weak risk management was further exacerbated when the banks experienced rapid growth; risk management and control policies failed to increase in sophistication as deposits and assets grew. And neither bank seemed to revisit the appropriateness of risk management, governance and internal audit policies nor whether their boards had experience levels commensurate with the institutions’ new sizes as they grew.

Silicon Valley Bank’s growth “far outpaced the abilities of its board of directors and senior management,” the Fed wrote. “They failed to establish a risk-management and control infrastructure suitable for the size and complexity of [the bank] when it was a $50 billion firm, let alone when it grew to be a $200 billion firm.”

The reports make a compelling argument that active and constant risk management plays an important role in the long-term financial solvency, success and continued operations of banks. Boards and executives at institutions of all sizes can learn from the risk management failures at these banks and revisit the appropriateness of their risk management principals, policies and models as the economy continues to shift. 

“The goal of risk management is not to eliminate risk,” the Fed wrote. “but to understand risks and to control them within well-defined and appropriate risk tolerances and risk appetites.”

Risk issues like these will be covered during Bank Director’s Bank Audit & Risk Conference in Chicago June 12-14, 2023.

Bank Failures Reveal Stress Testing Gaps

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Within days of Silicon Valley Bank’s failure on March 10, Democratic lawmakers quickly pointed out that the bank’s holding company, $212 billion SVB Financial Group, and $110 billion Signature Bank, which failed days later, weren’t subject to regular stress tests mandated for the largest banks under the Dodd-Frank Act. The requirement for mid-sized banks, between $50 billion and $250 billion in assets, had been rolled back in 2018.  

But the stress test scenarios developed by the Federal Reserve largely focused on adverse impacts on credit and declining interest rates. In contrast, SVB’s failure had its roots in a rising rate environment that led to an unprecedented deposit run; the Fed’s Vice Chair for Supervision, Michael Barr, testified on March 28 that customers were set to withdraw $142 billion in deposits over two days — roughly 82% of the bank’s total deposits.  

“When we think of stress testing, the key word is stress,” says Brandon Koeser, senior manager and financial services industry senior analyst at RSM US. “When you think of true stress and how that impacts the organization as a whole, it can be credit — but it should also hit liquidity, it should hit capital, and then look at earnings and profitability.” 

Internal stress testing is a regular practice for community banks, according to Bank Director’s 2023 Risk Survey. More than three-quarters of executives and directors say their institution conducts an annual stress test. This can be a valuable exercise that helps boards and leadership teams understand the impact of adverse events on their organization. 

Members of the Bank Services Program can access the complete results to all Bank Director surveys, by asset size and other attributes.

“Banks have enough resources, even small banks, to do some simple stress testing and put pen to paper,” says Patrick Hanchey, a Dallas-based partner at Alston & Bird. The results should be shared with the board, with the discussion reflected in the meeting minutes. “You can take small steps to show that you’ve been thoughtful,” he says. “That’s all the stress test is — thinking about, ‘What if x happens? What do we do, and how does it affect us?’”

Banks should build scenarios that consider account types and depositor behavior, says Sean Statz, a senior manager at Baker Tilly. “We’ve been doing data analytics on the loan portfolio forever,” he says. “Data analytics around the deposit portfolio is going to be a big focus to better understand what [the] portfolio is made up of [and] what could happen [so banks can] start applying some assumptions.” It’s easier to forecast behavior around assets, due to set terms around investments, borrowings and loans. Industry-level assumptions around deposit activity can help fill in some gaps.

The recent bank failures spotlight a key area of risk: deposit concentrations within particular sectors or industries. While much has been made of uninsured deposits, Hanchey cautions that these aren’t necessarily bad if they’re managed safely and soundly. Deposits from municipalities, for example, can be quite stable. Decision-makers should understand how those deposits are concentrated.

Hanchey adds that regulators within the Texas Department of Banking acted quickly to compare levels of uninsured deposits to the availability of other funding sources in a crunch, such as lines of credit from the Federal Home Loan Banks or correspondent banks. “Stress testing your FHLB advance capabilities, lines of credit from your correspondent banking relationships, access to the Fed [discount] window, all those traditional sources of liquidity that have always been important,” says Hanchey. “It’s a new focus on the interplay between those sources of liquidity and [a bank’s] ability to cover uninsured deposits.”

Scenarios should take multiple factors — credit, interest rates, liquidity — into account, helping decision-makers build a narrative that they can use to discuss and assess the impact on the organization, says Joe Sergienko, a client relationship executive at Treliant. They can then come up with a playbook for each scenario — essentially a decision tree that examines how leadership could react in different situations. “No scenario is going to play out exactly the way you forecast,” he says, “but it gives you [a] road map to say, ‘Here’s how we should manage our bank or our process through this.’”

And executives and boards should prepare for the absolute worst: the seemingly low-probability event that could break the bank, like massive outflows in deposits such as those that caused SVB and Signature Bank to fail. This reverse stress testing process provides clues to help leaders avert a disaster. At what point does the bank lose so much liquidity that it can no longer operate? How quickly could that occur?

Stress testing should help foster a larger conversation around risk, and strengthen risk management governance and policies, says Koeser. Scenarios and models should consider the bank’s size, geography and other factors relevant to the business, like concentrations on either side of the balance sheet.

Examiner scrutiny on risk management promises to get more onerous in the year ahead. “We should all expect the pendulum to swing toward heavy, heavy oversight and strict regulation of very discrete issues,” says Hanchey. “Banks should be prepared and have their answers ready when the regulators come in and ask them about things like deposit concentration, interest rate risk, stress tests, rising rate environments. The more proactive banks can be on the front end, the more pleasant their examination experiences will be.”

Community Bankers Emphasize Calmness, Stability Amid Crisis

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You can’t communicate too much during a banking crisis – even when your bank is not the one actually experiencing the crisis.

After regulators shut down SVB Financial Group’s Silicon Valley Bank and Signature Bank two weeks ago, community bankers across the nation began working behind the scenes to field questions from their boards, their clients and their frontline staff. They checked their access to the Federal Reserve’s discount window and sought to reassure customers and directors of their own institution’s liquidity position.

Locality Bank, a de novo bank based in Fort Lauderdale, Florida, still has ample liquidity from its capital raising efforts and simply by virtue of being a new bank. The $116 million Locality, which first opened a little over a year ago, reiterated these points in a letter it sent out to clients the day after Silicon Valley Bank was closed by state regulators, CEO Keith Costello says.

“We don’t have a portfolio of low-interest securities or loans,” the letter reads in part. “We have capital of almost three times the level required to have a well-capitalized rating, and our liquidity ratio at 54.17% at month end of February is one of the strongest in the U.S. Our securities portfolio, because we bought our securities when rates went up, has no appreciable decline in value.”

That letter went a long way toward assuaging customer fears around the ongoing banking crisis, Costello says, adding, “We just got a tremendous response from clients who emailed, who called, who just said, ‘Hey, we love that letter. We feel so much better about everything.’”

Communicating with frontline staff has also been critical, says Julieann Thurlow, CEO of Reading Cooperative Bank in Massachusetts. Not only are those workers spending a lot of time interacting with customers, but they also may have their own questions about how ongoing events impact their livelihoods.

“Not every teller reads The Wall Street Journal,” Thurlow says. “So make sure that you actually communicate with them as well because there was a level of uncertainty … ‘Is the banking community in trouble?’”

Some community bankers also took to social media to get the word out, including Jill Castilla, CEO of $358 million Citizens Bank of Edmond. Since the March 12 failure of Silicon Valley Bank, Castilla has taken to Twitter and LinkedIn to provide a rundown of the crisis and explain how Silicon Valley Bank and Signature differed from a typical community bank.

Even larger banks whose stocks have taken a hit sought to distance themselves from those banks. Phil Green, CEO of Cullen/Frost Bankers in San Antonio, Texas, took to CNBC to discuss the subsidiary Frost Bank’s liquidity position. The $53 billion Frost Bank CEO told “Mad Money” host Jim Cramer that the bank has a low loan-to-deposit ratio and roughly 20% of its deposits are held in highly liquid accounts at the Federal Reserve.

Even though Cullen/Frost Bankers’ stock price has taken a hit this year — down more than 10% since Silicon Valley Bank failed, mirroring the fall in the KBW Nasdaq Bank Index this year — Green expressed confidence in the long term.

“Frost Bank’s deposit base has been very strong,” he said, adding “We’ve seen really no unusual activity.”

While Reading Cooperative already tests its liquidity lines on a quarterly basis, the $796-million bank double-checked its access to the Federal Reserve’s discount window after Silicon Valley Bank failed.

“We could almost refinance the entire bank with our liquidity lines,” she says.

Meanwhile, Costello says that a handful of customers made their accounts joint accounts in order to get coverage from the Federal Deposit Insurance Corp., and he said that Locality also tapped its cash service with IntraFi, a privately held deposit placement firm, for the first time. He also added that Locality’s messaging around the crisis and its own liquidity position and relative stability resonated with non-customers, too.

“You find people that aren’t your clients will call you at times like this, too,” Costello says. “We did actually pick up some business as a result.”

Other community bankers also reported a similar experience picking up new business in the crisis. In a post on LinkedIn, Castilla reported that deposits continued to increase at her bank and “my lobby today is full of happy customers!”

Thurlow says Reading Cooperative picked up a few new larger accounts, although she was also cautious not to characterize that as a “flight to safety.”

“It’s not something that we’re marketing or looking to capitalize on,” she says. “This is a time for calm. We’re not looking to create or exacerbate a problem.”