- To accelerate profitable growth, regional banks will need to focus on growing the top line, recovering from spread compression and managing their loan-to-deposit ratio.
- C&I loans overall have been flat for two years, but private credit has taken off. Banks will have to innovate to compete, both within the commercial line of business and across the balance sheet.
- In an environment of significantly heightened competition, the risk to deposit costs is increasingly acute as competitors look to poach high-value depositors.
Banks entered the year with optimism in the air, hoping to benefit from growth-oriented economic policies and a less restrictive regulatory environment. Add to the mix a more favorable rate environment, and conditions appeared primed for growth, and valuations rose accordingly. Recently market conditions have become more uncertain. Still, banks need to plan for the high-growth scenario, which will require growing volumes on both sides of the balance sheet simultaneously while, at the same time, recovering the spread compression of the last cycle. No easy task.
To accelerate profitable growth, banks will need to focus on three things. First, they’ll need to find a way to grow the top line. Macroeconomic conditions should provide tailwinds, but at the same time banks will need to respond to the significant changes to the competitive environment of the past several years. Second, they’ll need to recover spread on their balance sheets. A steepening yield curve (if it lasts) should help, but despite strong beta pass-throughs after the 2024 Fed cuts, recovering from the increase in funding costs during the extended Fed plateau will take some work (Figure 1).
Figure 1: Average Net Interest Margin Over Time
Source: Curinos Analysis, SNL
Note: For Banks with $20B+ in assets, excluding FBO US branches and card issuers
Third, it appears that the era of excess liquidity is nearing its end. The largest banks remain flush with cash, but the loan to deposit ratios of regional banks are back in the 80s (Figure 2). And, importantly, the Fed Reverse Repo Facility, which has served as a shock absorber for the impact of quantitative tightening, is almost entirely drained (Figure 3).
Figure 2: Loan to Deposit Ratio by Bank Segment | 4Q24​
Source: Curinos Analysis, SNL
Note: For Banks with $20B+ in assets, excluding FBO US branches and card issuers ​
Figure 3: Overnight Reverse Repurchase Agreements |
July 2023 to Present​
Source: FRED Economic Data (St. Louis FED)​
To be sure, market conditions, which are always difficult to predict and impossible to control, will influence these growth drivers, and the greatest risks banks face appear to be in managing funding costs (Figure 4). Based on both the FOMC dot plots and the Fed Funds futures market, the outlook for further Fed cuts in 2025 has been pared from six 25 bp cuts to two 25 bp cuts. This will make it harder for banks to bring down deposit costs, especially if competition intensifies.
Figure 4: Portfolio Rate by LOB | Beginning vs. End of FF Plateau​
Source: Curinos Deposit Analyzer​
The Complication with Loan Growth
and How to Address It
Overall bank loan growth has averaged about 4% annualized since the start of the rising rate cycle. But underneath the headline numbers a few historically important segments have been exhibiting weakness. Accelerating growth will require either flipping the script in these areas or finding green fields in others.
In commercial, C&I loans overall have been flat for two years (Figure 5). At the same time, the explosive growth of private credit has been taking share (Figure 6). It’s possible that a credit event will reset investor appetite for private credit at some point, but until then, this is a serious structural headwind. Banks will need to innovate to compete, both within the commercial line of business and across the balance sheet. Several banks have articulated strategies of pursuing treasury management and deposit-led relationships with private credit-funded companies. Others are engaging segment-expertise-led strategies to differentiate themselves through underwriting and cash management solutions.
Figure 5: Commercial and Industrial Loans – All Commercial Banks | 2020 to Present
Source: FRED Economic Data (St. Louis FED)​
Figure 6: Private Credit Market Share​
Source: Curinos Analysis of Public Data​
Mortgage volumes have rebounded from severely depressed levels, up 10% YoY for purchase, but remain low by historical standards on stubbornly high rates, the lock-in effect, limited inventory and continued home price appreciation. At the same time, independent mortgage brokers are taking increasing market share as borrowers prioritize speed and convenience—IMBs’ traditional areas of competitive strength. Part of the volume equation will require investments in marketing and customer experience. But the upside is that the data suggest there’s room to improve returns on pricing. Meanwhile, unsecured lending remains a bright spot, with bookings up 8% year over year.
In small business lending, applications are vastly outpacing booked volumes for all credit types except SBA, which indicates continuing high unmet demand, especially among micro-businesses. As a result, flexible financing options remain a high priority for business owners, and there’s still meaningful white space in this lending category for banks to capitalize on.
Last year, nearly 60% of the demand for loans under $250K came from small businesses generating less than $500K in annual revenue. Yet only 25% of these loans were funded, leaving a yawning gap in the market. Some forward-thinking lenders are closing it by going beyond traditional credit scores, leveraging alternative data and behavioral lending models to better assess risk and thereby serve these businesses more effectively.
The Complication with Deposits and How to Address It
Industrywide, deposits are churning, but they’re not growing a whole lot. Top performers may be printing high single-digit growth across segments, and direct banks may have taken significant share, but overall supply is largely unchanged over the past three years and remains lower than from the Covid-era stimulus peak. Even with banks generally well-funded, deposit costs escalated rapidly during the Fed plateau. The most rate-sensitive deposits segments repriced quickly, with betas in Wealth and Commercial over 40% for the 2024 rate cuts and over 50% for direct banks. In Consumer and Small Business, however, those betas were less than 15% (Figure 7), largely because so many of those deposits were already priced at or near zero.
Figure 7: Falling Rate Deposit Beta | Current vs. Last Cycle1
Source: Curinos Deposit Analyzer
Note(s): 1) Current cycle defined as Aug – Dec ’24 (100-bp cut); Last cycle defined as Jul – Oct ’19 (50-bp cut)​
In a base case of gradually falling rates, wringing additional spread out of those deposit books would be hard enough. But in an environment of significantly heightened competition, the risk to deposit costs is more acute as competitors increasingly look to poach high-value deposits. Clearly that’s what we’ve seen over the past year in Small Business, where interest-bearing acquisition costs are now in line with the deposit segments that traditionally have been the most rate-competitive.
A great antidote to rising portfolio costs is primary checking acquisition. But even here, with customer acquisition costs skyrocketing, the economic tradeoff between marketing expense at rate-based offers is increasingly dynamic.
In this potentially more competitive scenario, precision will really matter. That means having the tools and data-driven analytics to acquire and retain selectively while at the same time minimizing large moves on the back book. This is true within businesses but also across businesses as bank treasurers wrestle with optimizing the funding stack.
Putting It All Together
The future is bright, but winning will be hard. For most banks, it will require growth on both sides of the balance sheet – and it’s been a while since the industry has done both simultaneously in a big way. From a lending standpoint, precision pricing, targeted marketing and product innovation are the controllable variables. From a deposit standpoint, the scenario that’s tricky to manage is high-growth, higher-rate. The key will be figuring out when and where to use price offensively, and defensively, and how to insulate the rest of the book.
In any scenario, a focus on the primary customer remains the North Star. But even then, in the more competitive scenarios we imagine, that may not always be enough. Within the broad strategic framework, there increasingly may be a role for tactical optimizations. The articles that follow will unpack some of the underlying tactics for both strategic growth and tactical optimization within key customer segments.
