Commercial Deposit Betas: Why it's Important to Optimize
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Commercial deposit betas measure the degree of sensitivity of deposit rates to changes in the Fed funds rate and are expressed as a percentage of those changes. If, for example, the Fed funds rate rises by .5% (50 basis points) and a financial institution (FI) raises rates on its deposits by an average of .2% (20 basis points), the beta on those deposits is 40% (.2% = 40% of .5%).
Deposit betas indicate the degree to which an institution follows the trend of short-term market interest rates in setting its own rates. If deposit betas are below 1%, the deposit rates are said to lag market rates. If they are above 100%, the institution has elected to be more aggressive in its rate setting than the current market would indicate.
In today’s banking marketplace, FIs typically display an array of rates and corresponding betas depending on which customer segments they are looking to attract or retain and at what rate. If they have an appetite to increase their deposits, their betas for new-to-bank money, reflected in their “acquisition rate,” may exceed 100% and be considerably higher than their “portfolio rate,” which is the blended rate paid on its current balances. If they’re satisfied with their level of deposits or don’t want to incur added interest expense, they may move their rates upward more slowly than market rates, if at all, thereby displaying a beta of less than 100%. Optimizing betas means achieving desired deposit volumes at the lowest possible cost.
Rates paid on deposits generally lag fed actions
Past rate cycles have shown that deposit betas at most traditional banks lag action taken by the Fed, whether rates are moving up or down (Figure 1). At the beginning of the upward phase of the cycle, most banks are loath to reprice balances held by deposit holders who may be indifferent to receiving a higher rate. These providers are protecting their “back book” even at the expense of not adding significantly to the front of the book. Then, when the cycle turns downward, many may not wish to risk balances running off the books by lowering deposit rates too aggressively. In both cases, where a significant existing deposits are in play, betas for these banks are typically less than 1% – they intentionally reprice more slowly than the Fed when it moves its market rates.
Figure 1: Cost of Interest-Bearing Domestic Deposits as % of Deposit Balance
Overall, bank deposit prices have historically lagged movements in the Fed Funds rate.
Source: Federal Reserve, FDIC, Novantas Analysis
Note: All figures represent interest-bearing domestic costs and deposits in all commercial banks
This is in contrast with most fintechs and direct banks, many of which have a much smaller back book to protect. In these cases, especially in a tightening rate environment, betas can be well above 100% in order to attract new money before the competition can. As their balances grow, however, they too need to guard against deposit flight, and their task when rates are falling may be more difficult than that of traditional banks. That’s because most of the customers they’ve attracted have come to expect higher rates and are more likely to switch providers for a more attractive rate. But if these providers shrink their betas, many may forfeit the very value proposition that got them to where they are in the first place.
Managing Beta in Commercial Deposits
One of the most effective ways of optimizing betas is to understand how different customer segments respond to changes in rate. Commercial deposits, for example, is a segment of the market where low betas have contributed to bank profitability over the years – but that’s changing. As market rates have risen, so too have betas because corporate CFOs and treasurers are increasingly demanding optimal returns on their cash. That’s set off a migration of corporate cash from non-interest-bearing accounts to interest-bearing.
Figure 2: Average Commercial Portfolio Rates
As the rate gap between ECRs and interest-bearing accounts widens, corporate clients will likely continue their move toward the higher-rate options
Source: Curinos Commercial Analyzer.
Contributing to the speed of the migration has been the diminution of the earnings credit rate (ECR) as a method of payment to banks for services received from their corporate clients (Figure 2). ECRs were conceived as a result of Regulation Q, which stipulated that banks were forbidden from crediting interest on cash left in corporate demand accounts. In lieu of interest, banks began in the 1970s to credit their client accounts with an amount that covered the services they provided in treasury management, payments and other corporate services. But since Reg Q was repealed in 2011, banks have been able to pay interest on deposits, and as rates have risen, these credited rates have significantly eclipsed what banks have been able to justify as payment in ECRs for their corporate services. This has helped send betas spiraling upward on corporate deposits and all but removed corporate deposits as a reliable source of low-beta bank funding.
Optimizing beta is key to optimizing profitability
Betas measure the relationship between short-term market rates, specifically those set by the Federal Reserve, and what financial institutions charge their customers or members for their deposits. They are thereby a gauge of an FI’s funding costs and, along with interest earned on its assets, determines net interest margin and, ultimately, profitability. That’s why optimizing beta is so important. It defines the most favorable intersection of desired deposit volume and the cost needed to achieve it.
But optimizing can be as complex as it is fast-moving, which is why analytical tools are generally required to truly optimize. These include three provided by Curinos, Inc: Curinos Commercial Analyzer, Curinos Commercial Digital Analyzer, and Curinos Commercial Optimizer. For institutions with significant deposit books, putting them to work has been shown to yield multi-million-dollar annual improvements to their bottom lines.
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FAQs
What is a deposit beta?
Deposit betas measure the degree of sensitivity of deposit rates to changes in the Fed funds rate and are expressed as a percentage of those changes.
What are deposit betas used for?
Deposit betas allow financial institutions to measure the speed and level to which the interest rates they pay on their deposits coincide with the Fed Funds rate. To the extent FIs have access to rates paid by other institutions, it also provides a measure of their rate behaviors versus the competition.
What does it mean when a deposit beta is more than 100%? Less than 100%?
A deposit beta of more than 100% means an institution’s rate paid on its deposits has moved greater than the Fed Funds rate. A deposit beta of less than 100% means an institution’s rate paid on its deposits has moved less than the Fed Funds rate.
Why do deposit betas matter?
Deposit betas are a valuable and universally accepted metric for an institution to compare what it is paying on its deposits to market rates and to rates paid by its competitors. Using deposit betas makes it easier for institutions to analyze and understand their position in the deposit marketplace.
What are typical deposit betas?
As a rule, the more liquid a deposit – such as checking, savings and money market accounts – the lower the beta on the account. That’s because depositors are willing to accept rates below market rates for immediate access to their funds. Term deposits, which limit access to funds for set periods of time, generally have higher betas, and except in periods when the Yield Curve is inverted, the longer the term, the higher the beta.
Do deposit betas vary by types of deposits?
Yes. More liquid accounts tend to display lower betas than term accounts, and Commercial and Wealth deposits tend to display higher betas than Consumer and Small Business accounts. That’s because certain customer segments typically demand more on their deposits than others. Wealth clients, for example, have greater access to higher-paying nonbank alternatives. Small Business deposits, on the other hand, require lower rates because so much of a small business’s deposits are tied up in non-interest-bearing demand accounts for its operating needs.
Why is understanding deposit betas important to bank profitability?
Rates paid on an institution’s deposits vary significantly by type of customer and type of products they favor. Measuring what’s paid on all deposits and optimizing what needs to be paid on each type is critical to minimizing deposit costs while maximizing the probability of retaining those deposits, both factors of which influence net interest margin and overall profitability significantly.
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