This Month in Commercial Banking unpacks early reaction to the March Fed hike and potential implications from the upcoming May meeting. Between anticipation of a 50 bp rate hike and signs that point to a faster-than-expected pace of balance sheet reduction, things are likely about to get more complicated. Additionally, with inflation at a 40-year high, excess liquidity and the potential for rising ECRs, the stage is set for transformative TM fee pricing events in 2022.
Also, commercial digital platforms are increasingly central to catalyzing growth across the commercial product ecosystem. We cover five key investment areas that can accelerate primary customer acquisition and retention. And rounding out this month, we bring insights from our Treasury Strategies practice on the priorities, risks and opportunities that are top of mind for corporate Treasurers.
Calm Before the Storm
There was a fairly mild reaction to the initial 25 bp increase in the Fed Funds target rate last month. Banks reported that their largest and most rate-attuned commercial customers requested exception rates at the time of — and in some cases even before — the March FOMC meeting. But the volume was a trickle, not a deluge. This is also confirmed in end-March Curinos CDA data that showed average interest-bearing rates rose just two bp from February to March — a beta of just 8%. (See Figure 1.)
But things are about to get more interesting.
Inflation has continued to trend upward since March and the FOMC members have signaled a high probability of a 50 bp increase in the Fed Funds rate at the upcoming May meeting. More significantly, minutes from the March meeting indicate that members of the FOMC generally agreed that a significantly faster pace of balance sheet reduction than was implemented in 2017-2019 would be appropriate. The mostly likely trajectory appears to be rapidly-scaling balance sheet reduction to a base of $95 billion per month.
Figure 1: Change in Average Commercial
Figure 2: Year-Over-Year Commercial
Deposit Growth by Month
This pace would be slightly faster than the rate at which the Fed increased the balance sheet at the height of the pandemic and at approximately twice the clip of the 2017-2019 reduction.
This is a big deal for commercial deposits.
Curinos has long said that there are strong structural supports to continued elevated levels of commercial deposits and that it would take a significant exogenous event to turn the tide. A reduction of $95 billion per month in the Fed’s balance sheet would be such an event. This pace of quantitative tightening will likely modestly outweigh the impact of the money multiplier effect, as well as the rotation of deposits from consumer to commercial accounts when individuals continue to unleash the spending that evaporated over the past two years.
As such, the mostly likely trajectory for commercial deposits over the next twelve months is now flat to modestly lower. This represents a shift in our perspective relative to the beginning of the year and is driven predominantly by the faster pace of quantitative tightening that the FOMC appears prepared to undertake.
To be clear, most banks are still sitting on unprecedented levels of excess liquidity and many will remain flush with funding for a considerable amount of time. At the individual bank level, however, the increased pace of quantitative tightening will lead to greater variability in balance performance. This is starting to flow through into overall balance numbers, with average year-over-year growth of less than 1%. (See Figure 2.) This will likely accelerate as the Fed ramps up quantitative tightening. This will, in turn, add to competitive pricing pressure as pockets of rate competition emerge throughout the market.
Some of the facts on the ground have shifted. We expected this. The hallmarks of this cycle are complexity and uncertainty. What hasn’t changed is the tools needed to navigate this cycle. Leveraging data and analytics to systematically measure customer relationship primacy are key to anticipating which balances will stay and which will go. These analytics are also the foundation of strategic pricing.
Use Your Digital Platform to
It wasn’t so long ago that commercial digital offerings were seen as efficiency plays that reduced servicing costs while generating line-item fee revenue. But with steady investment by banks and innovative disruption from fintech providers, commercial platforms now offer solutions that deepen relationships by creating a full-service platform that seamlessly integrates omnichannel access with targeted marketing, products and solutions. This opens a new dimension to the value proposition, complementing the relationship manager and treasury management officer in acquiring, deepening and retaining primary relationships.
Curinos has identified five key investment areas to maximize client value, solidifying primary customer relationships and expanding the client base.
- Onboarding: Customer experience starts with onboarding — an area where banks have traditionally struggled. And with onboarding, time is literally money. The faster a bank can onboard payments and account infrastructure, the faster it can monetize fees and core operating deposits. Moreover, a good onboarding experience is likely to drive additional services in the future, whereas a poor onboarding experience can have the opposite effect. As our previous research has shown, digital onboarding is a top investment area for commercial banks, so the stakes are getting higher.
- Payment suite: Develop a complete payment suite and allow customers to select the payment method under the parameters of cost and fund availability. Take it a step further and adopt a user-centric approach that builds in AI to provide tracking and transparency. Simplify the selection purchase by allowing the platform to select the rail based on historical trends and company limitations. There are a wide range of faster payment options on the market, with different limitations and use cases. A full payment suite includes all available options on the market, including ACH, real-time and instant payment rails, wire and SWIFT. It is important to integrate new payment methods when they become available, including digital disbursements and virtual cards. Enhanced security can generate revenue in the form of fewer fraud payouts.
- Concentrate on credit: Tighter integration of the lending process and the payments process within a unified commercial digital experience is crucial for revenue growth. The process needs to be transparent, with an audit trail that shortens decision turnaround time and reduces fraud and customer frustration. The ability to view and embed the process online allows for same-day action, minimizing delay in application review. Platforms should have the capability to disburse loans, collect repayments and draw additional funds remotely through digital channels. Digital automation can save hours in processing time and reduce internal costs per loan, all while expanding geographical footprint.
- Dynamic dashboards: Interactive dashboards bring transparency and financial data to the user’s fingertips. Customers can get a real-time view of liquidity/cash positioning, along with advice on where and how to invest in the bank’s available product set. Customers can then engage with new solutions tied to financial health. Investment advice, similar to robo advisors in the retail line of business, can also help commercial clients.
- Digital marketing automation: Tying it all together, investment in digital marketing automation can capitalize on integrated data and solutions to help banker and clients identify the next solution. Bringing it full circle, digital marketing insights can also support both new customer and second product onboarding.
By doubling down on the digital investments that drive client value, banks can transform digital from a line-item fees and efficiency play to a foundational ecosystem enabler that catalyzes primary client growth and retention.
Stars Align for Transformational
A confluence of factors in the economy and financial markets is creating a once-in-a-cycle opportunity to pursue more transformational treasury management price increases. First, inflation continues to run at 40-year highs, in the 7%-plus range. This is a fundamentally different anchor point relative to the past decade in which inflation has typically run at or below 2%. Second, excess liquidity and rising rates provide some air cover. Higher betas on ECR will mute the near-term customer impact while providing a substantially more favorable fee foundation for the next down cycle.
Given the complexity of TM pricing models, transformational results will require a deft touch.
In the past decade, banks have reduced costs through digitization and few providers were able to tie price hikes to inflation when it was at low levels. With inflation now at a 40-year high, this is the time to raise prices.
Curinos sees three basic approaches to approach TM price increases in 2022, each anchored to the theme of inflation. (See Figure 3.) Of the three, the broad-based strategy is the easiest to plan and execute, but it has the weakest link to the current environment. Also, we have heard anecdotally from many banks that the price increases of the last two years were focused on high visibility and core services. To complement broad-based increases, banks may have an opportunity for additional repricing for high-cost, high-touch services. This also aligns with the Curinos key value drivers framework for TM pricing, which generally suggests higher price points for heavily customized services and penalty pricing for inefficient services.
Figure 3: Approaches to TM Pricing in an
The current market conditions have created a unique opportunity for banks to set a new floor for TM pricing for the coming years. There are pros and cons to each approach, but we believe ultimately that execution will be as important as strategy when pursuing more transformational pricing opportunities.
With banks sitting out 2020 and obtaining a high portion of their planned tactical increases in 2021, there is a chance that banks are rusty on the core skills, processes and governance required to obtain 5%+ price increases without creating major disruptions among their current portfolios. A strong communication and feedback program with the front line and other internal stakeholders will be critical to optimizing pricing opportunities.
Rates, ESG and Global Unrest are
big Issues for Treasurers
The State of the Treasury Profession is an annual survey that tracks the priorities, risks and opportunities for treasurers across a wide swath of industries. Conducted by Treasury Strategies, the corporate treasury unit of Curinos, this year’s survey reveals that rising interest rates are considered as both a risk and an opportunity for Corporate America. Not surprisingly, the crisis in Ukraine is viewed as a new risk. In better news, ESG has emerged as a new priority.
The following is a breakdown of the key findings:
- Enhanced liquidity management. These efforts include both reconsidering optimal balance sheet structure as well as increased attention to management of short-term liquidity and working capital accounts.
- Digital. Treasurers know that improvements in treasury and financial transaction processing requires enhanced use of existing technology and acquiring additional technology tools. Many aren’t confident that their employees are getting full value from earlier investments in technology. They feel that they personally need to devote more time to leading these efforts.
- Bank primacy. Treasurers are aligning bank service offerings with the growing technology needs of their companies. In a few cases, this includes selecting new banks to support them. Treasurers say they need to be more proactive in understanding their banks’ newest products and services. Some treasurers are prepared to change banks to gain access to the technology that their companies need. These ideas are especially strong at companies that are consumer-facing.
- ESG. Environmental, social and corporate governance responsibilities weren’t mentioned by treasurers in previous surveys. This year, all treasurers specified this as a corporate priority; many have specific roles in these corporate-wide efforts.
- Internal controls. Introduction of new technology associated with cash management, combined with adoption of work-from-home protocols, are prompting treasurers to reexamine the controls that were put in place to mitigate risks associated with previous technology and work protocols.
- Human capital management. Retention and recruitment of staff is a concern of nearly all treasurers. While corporates have taken steps to mitigate staffing risks, most treasurers aren’t confident that they are doing all that they should. They are especially concerned with the training of new young staff members.
- Rising inflation and interest rates. Treasurers recognize that elevated levels of inflation will lead to rising interest rates. They also recognize that rising interest rates are a two-edged sword that increase the yield on their cash while raising interest expense on borrowings. Several treasurers expressed concern that these rate increases might continue until 2024.
- Fraud. This includes both traditional types of fraud as well as the increasing sophistication of cyberattacks on companies and their banks. Corporates have devoted resources for several years to improving protection against electronic fraud, especially those threats against their disbursement operations. Interestingly, few corporate treasuries have focused attention on the threat of losing access to their bank services if an attack made their bank inaccessible.
- Supply-chain disruptions. The strain on the supply chain is impacting working capital accounts and overall operations and profitability. Firms that import and export products are experiencing disruptions to their FX cash flow hedging programs because delayed shipments affect the timing and exact amount of payment in foreign currencies.
- Geopolitical risks. The combined impact of government reactions to COVID-19 and the crisis in the Ukraine creates risks with effects that nearly all treasurers said are unpredictable in terms of both effects and appropriate responses.
- Rising interest rates. Treasurers recognize that rising rates promise increased interest earnings on their short-term cash balances. Low interest rates on cash balances have been a point of frustration for treasurers for years and they are keenly interested in how and when banks will increase the earning credit rates on their cash balances.
- Digital. Treasurers are primarily focused on end-to-end automation of incoming and outgoing payments. The scope of these efforts starts with receipt and delivery of invoices and ends with efficient receivables application and account reconcilement. Few corporates are focusing on receivables and payables improvements simultaneously; they are selecting only one of these payments processes as their priority. In addition, leveraging existing investments in technology to enhance liquidity management through improved cash forecasting is rapidly becoming a more urgent priority after years of benign neglect resulting from high cash balances and low interest rates.