This Month in Commercial Banking: Managing the Business as Rates Rise

The Federal Open Market Committee just announced another interest rate increase of 75 basis points. Commercial deposit rates were already on the rise before this latest hike and we expect the trend to continue, especially as more of the back book starts to wake up. ECRs have started to wake up as well. Without a carefully coordinated treasury management fee strategy, higher ECRs may result in both lower net fee capture and an increase in excess balances rotating into higher-rate accounts.

Meanwhile, budgeting season is around the corner. With digital platforms continuing to drive growth and deepen relationships, we consider the elements of a best-in-class digital roadmap and how to get the most out of your upcoming budgeting exercise.

Finally, we take a look at another core platform in companies’ digital toolkit — the treasury management system — and how careful selection and successful implementation can drive better operating efficiency and risk management.

Agenda

Commercial Balances Hold Up
(Pretty Well), but Rates are on the Rise 

The FOMC is attempting to thread a needle and tame inflation while sticking a soft landing and avoiding recession. That is a big task, especially as inflation stands at a 40-year high and other macro-economic challenges abound.

Commercial liquidity managers are attempting to thread a needle of their own. They must manage betas and protect primary customer relationships, while also preserving optionality on non-operating balances should new funding needs arise. As the FOMC takes more drastic measures to regain control over prices, commercial liquidity managers are facing a higher degree of difficulty as well.

The most recent Curinos data show that, on average, balances levels remain soft but stable, while interest rates are beginning to move up more sharply. Looking through the averages, we also see that the dam has begun to crack at banks in the bottom quartile for balance outflows and the top quartile for betas. (See Figures 1-4.)  

Figure 1: Total Commercial Deposit Balance Growth (June 2022)

Source: Curinos CDA

Figure 2: Monthly Total Commercial Deposit Balance Growth (March ’22 to June ‘22)

Source: Curinos CDA

Figure 3: Commercial Bank Average Portfolio Rate (March to June ’22)

Source: Curinos CDA

Figure 4: Commercial Bank Average Portfolio Rate By Quartile (June ’22)

Source: Curinos CDA

Looking forward, the implications of these early portfolio moves are significant. On a pro-forma $10 billion in interest-bearing commercial deposit portfolio, the difference between average and top quartile amounts to $30 million per year in incremental interest expense. And this gap has the potential to expand as rates rise further.

Furthermore, there is another shoe to drop that will further complicate the outlook. Standard prices have yet to move, apart from in isolated pockets of the market. With 40% of interest-bearing portfolios still priced at standard rates, even a modest increase will have a significant impact on total portfolio interest expense.

In the long run, the way to manage these costs is through growing the share of primary operating accounts in the deposit book. But there are still things that can be done in the near term, including strategic use of rate benchmarks, investing in deposit analytics, planning to manage standard rates more surgically when they do begin to move and enhancing deposit governance.

Peter Serene (peter.serene@curinos.com) and Jing Tang (jing.tang@curinos.com)

Coordinated Management of ECRs and Fee Pricing is Essential

ECR betas trailed far behind betas on interest-bearing products in the last rising-rate period, staying around 15% through the cycle. But according to the latest Curinos Commercial CDA Executive Summary, commercial liquidity managers expect higher ECR betas this time around. (See Figure 5.) And while ECR rates didn’t move through the first three months of this cycle, they increased by five bp on average from May to June. (See Figure 6.)

ECR and rates and treasury management fees are two sides of a coin. In a perfectly rational world, companies would maximize total return across interest income and out-of-pocket bank fees. And banks would price on an all-in basis indifferent to being paid in hard dollar fees or free balances. But reality is messier.

Figure 5: ECR Beta Expectations

Source: Curinos CDA

Figure 6: Average Portfolio ECR Rates (Year to Date)

Source: Curinos CDA

Outside of the leading treasury-management practices, we often find that there is opportunity for significantly greater coordination in relationship pricing across ECRs and treasury management fees. Banks that haven’t optimized that coordination often end up offering clients both high ECRs and deep TM fee discounts. This results in a significant reduction in “free” compensating balances that are a key driver of relationship value for the bank.

Instead, banks must decide how to provide their clients value between ECR and TM fee pricing — and make sure their relative positioning is aligned. Banks that want to provide a competitive or premium ECR should make sure that TM fees are more fully priced to keep balance requirements high and ensure that low cost and stable deposits are captured. Banks that want to focus on providing TM fee discounts should ensure that ECRs aren’t too high and erode the level of hard dollar fees that are captured.

The current combination of high inflation, high liquidity and rising rates has provided commercial banks a unique opportunity to set a new baseline for their TM fee pricing and ECR approaches. Curinos has previously written and spoken about the importance of fee increases in 2022, but effective ECR management can also drive significant value too. National, super-regional banks and the top performing regional banks capture a record high of more than 80% of their gross fees as hard dollar fees. (See Figure 7.)

Figure 7: Annual Fee Capture Rates (Net TM Fees After Earning Credits / Gross TM Fees)

Source: Curinos CDA

While it is unavoidable that fee capture rates will decline, disciplined ECR management can materially boost the bottom line. For a bank with $25 million in annual gross TM fees, every 5% of fee capture retained is equivalent to $1.25 million in hard dollar fees.

Additionally, effective ECR management will help to keep balances in DDA by maintaining balance requirements. We have found that the difference between a 12% beta for ECR and a 28% beta in the current rate forecast can help keep around 30% more in compensating balances. This translates into interest spread savings in the tens of millions of dollars for banks that have more than a couple billion dollars in analyzed DDA. The ability to keep ECR betas down and fee capture rates high will dramatically impact financial performance in this challenging cycle.

Scott Musial (scott.musial@curinos.com)

Best Practices for Building a Digital Roadmap – It’s Worth the Effort

As banks move into 2023 budgeting season, some of the most consequential decisions commercial banks will make center on digital investments. But this process is complicated by three key factors.

First, the competitive landscape is changing rapidly. With digital-first banks and BaaS-enabled payments providers entering the market and the continued proliferation of commercial bank/fintech partnerships, traditional bank offerings are being challenged. Second, commercial platforms are complex to navigate with many features hidden behind the firewall, complicating competitive benchmarking. And finally, long budgeting cycles requires banks to see around corners in laying out their digital roadmap.

Given these complexities of digital planning, a good process can make a big difference. In our experience, best-in-class digital planning processes have a few key elements in common.

  1. Clear understanding of the needs of your target customers including segmentation and verticals. The digital platform strategy should be tightly coupled to the broader business growth strategy.
  2. Structured competitive assessment to understand how your platform compares with your competitors and how digital capabilities fit into your value proposition to the client.
  3. Investments should address remediation (where needed), emerging table stakes functionality and innovation in a deliberate fashion. For some banks, a handful of targeted “leapfrog” bets may be appropriate.
  4. The roadmap should consider a range of delivery models including build, buy and partner.
  5. The roadmap should anticipate investments and competitive evolution of a multi-year horizon and consider the impacts of potential technological innovation as well as changes in customer preferences and market conditions.

 

Developing a structured digital roadmap takes work and requires structured insights into competitor offerings as well as customer preferences. But the payoff is big in terms of maximizing the return on a long-term investment into the platform that is — for a growing share of commercial clients — their front door to the bank.

Jennifer Sypal (jennifer.sypal@curinos.com)

Getting the Most Out of a Treasury Management System and Bank Data

The case for treasury management systems (TMS) and effective use of bank data has never been stronger for corporate customers. Some of the benefits include:

  • Integration between a bank’s accounting system and a company’s accounting system dramatically reduces labor time, accelerates accounting close processes and reduces the number of reconciling items associated with cash accounts.
  • The bank reconciliation process becomes so efficient that it can be performed daily instead of weekly or monthly. This enhances controls and improves the quality of the accounting process.
  • The highly-automated interface between bank systems and a corporation’s TMS improves short-term liquidity management through better and earlier visibility to cash activity. This permits earlier borrowing and investing decisions that result in better rates for borrowings and investments.

 

But adopting these systems isn’t so easy. Vendor selection can be time-consuming and confusing. It can be difficult to find meaningful points of vendor differentiation. It is also difficult to assess how the system will work in the corporate’s environment.

Treasury Strategies, the corporate treasury consulting branch of Curinos, has identified three key ways to ensure a successful selection: strong project leadership, a comprehensive process and detailed vendor demonstrations.

  • Firms that combined external consultants with internal treasury resources to lead their selection project report the highest overall satisfaction.
  • Most organizations include a business case, request for proposal, vendor demonstrations and calls to references among the steps in a system selection project.
  • Companies that used custom vendor demonstration scripts in their selection process report a higher satisfaction with both selection and implementation. Experienced outside consultants use their knowledge of company-specific requirements to design vendor demonstrations that showcase the most relevant product capabilities. Such tailored vendor demonstrations are a crucial part of a treasury system selection.
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