Happy New Year! The first 2022 issue of This Month in Retail Banking dives into some proprietary research, new areas that banks should explore and, of course, implications of higher rates.
We start with a recent round of Curinos research into the mass affluent – a customer base that is extremely valuable to banks, but often elusive. The problem: banks tend to treat all mass affluent customers the same.
Next up are two sections that deal with the prospect of rising rates. Not surprisingly, direct banks aren’t waiting for the Fed to make the first move. For those institutions that are considering M&A, higher rates will be increasingly important when it comes to deal integration for the first time in years.
Finally, we examine two burgeoning areas that should attract more attention from financial-services companies in 2022: financial wellness and embedded finance. It’s time for providers to start staking a claim in both.
What Do Mass Affluent Customers Need?
Retail banks often struggle to capture meaningful wallet share of mass affluent consumers, and with so many banks pivoting to a mass affluent strategy, the competition is only increasing. These consumers are particularly valuable due to their larger assets, need for multiple financial products and possibility of future migration to private banking.
But not all mass affluent customers are the same.
Appealing to this segment requires a different set of capabilities and features than the mass market or wealth strategy. Recent research conducted by Curinos found that mass affluent customers are somewhat open to financial advice from bankers. (See Figure 1.) As consumers become more affluent, however, there is a decided preference for a financial advisor. While this may be intuitive, other preferences don’t vary for different levels of affluence (or age).
Figure 1. Preferred Forms of Financial Advice by Asset Size
Because mass affluent is defined so broadly, there is value in further defining target sub-segments within the broader mass affluent population. Financial needs and attitudes, not just affluence and life stage, can support a segmentation framework. Based on this segmentation, banks can refine their value proposition to address the needs and preferences of target segments.
Direct Banks Fire Shot Across the Bow on Rates
It’s no surprise that traditional financial-services providers are taking a wait-and-see approach to the prospect of rising rates when it comes to their retail customers, but that’s not the case for direct banks.
Curinos data reveal that more than 25% of direct banks increased rates on at least one product by an average 15 bp at the end of last year. CDs that carry a term of 24 months or longer showed a particularly sizable increase of 51 bp. (See Figure 2.) The moves, which come after two years of rate reductions, reflect a steepening yield curve and expectations that the Fed will soon start hiking rates.
Figure 2: Share of Direct Banks with Rate Increases
Rate Change from Nov. ’21 to Dec. ‘21
If bankers at traditional institutions want a glimpse of how things have changed since the last rising-rate cycle, this is a good example. While many banks have excess liquidity from surge deposits in 2020-21, many direct banks without checking bases may not have that luxury and will need to be aggressive in wooing new deposit customers. Furthermore, there are a slew of new fintech players that didn’t even exist the last time around and their customer base is growing.
The upshot is that it will be tricky for traditional banks to decide how to respond when rates rise. While deposit growth may not be needed in the short run, retaining customers with long-term value remains critical. Fortunately, there are advanced analytics and tools to help figure out which customers are primary, which deposits are likely to bolt and what customers want from their providers. These will be an integral part of decision-making in 2022.
A New Focus on M&A Integration When Rates Rise
We’re now almost two years into the COVID-19 pandemic, and after an initial lull in M&A, a flurry of deals were announced in late 2020 and throughout 2021.
While completing a major integration in a largely remote work environment is no small feat, one thing acquiring banks haven’t had to worry about in the past two years is proactively managing and integrating pricing strategies. Why? Because banks have largely kept rates flat as the broader interest rate environment has been at rock bottom – they’ve had little to change throughout the last two years.
Those days are likely over; buyers will no longer be able to ignore pricing strategies during an acquisition. We are likely to see three-to-four interest rate increases in the next year, with a few more in 2023 and 2024 as well. (See Figure 3.) That means interest rates at the time a bank announces an acquisition are likely to be materially different by the time the deal closes or bank conversion is complete. Gone are the days of passive deposit pricing during an integration.
Figure 3: Target Fed Funds Rate Probabilities
This has two key implications. First, it highlights the importance of deposit due diligence as winners and losers will reveal themselves as rates rise.
Second, acquirers will need to be more proactive about managing pricing strategy after Legal Day One. This entails optimizing pricing across legacy brands (and their regions and products) in a more dynamic rate environment. Banks will need to consider how to lag betas as rates rapidly rise; product conversion should take that into consideration. To the extent banks leverage customer-level pricing and offers, these should be implemented across legacy brands as soon after Legal Day One as possible. Additionally, merging banks with materially different legacy pricing strategies will need to develop a harmonization plan that is best suited for the combined bank and its clients.
The best acquirers leverage clean rooms to complete the necessary work ahead of Legal Day One so they can act as quickly as possible after the deal closes.
Without proactive planning, there is a major risk that the combined portfolio will be sub-optimally positioned for the rate environment by the time a target bank’s deposit portfolio is fully integrated with the acquirer. After all the time, money and effort that is spent in bringing an M&A deal to completion, this is a risk that buyers can’t afford to take.
Financial Wellness: A Path to Customer Loyalty
COVID-19 has put many Americans into a financial tailspin as they experience wage stagnation, job loss and rising expenses. Although many consumers bank with a financial institution, they seem to feel alone when it comes to managing their finances.
In fact, a poll from the National Foundation for Credit Counseling found that less than 50% of consumers trust their financial institution to look after their long-term financial well-being. And only a small percentage of consumers say they have enough savings to cover six months of living expenses.
Financial institutions have a huge opportunity to reshape their offerings and include financial wellness in their core services, potentially leading to future growth.
But what role should financial institutions play in helping their customers achieve financial wellness? In a nutshell, financial wellness is achieved when people can apply knowledge to manage their economic lives effectively, allowing them to make sound financial decisions, spend within their means and save adequately for future emergencies.
Some of the fundamental principles to helping customers achieve financial wellness include the following:
- Institutions should proactively give advice that is easy to find and offer customers an understanding of where they are in their financial journey
- Financial wellness must include contextual advice and tools that consumers can use in their everyday lives
- The advice should be automated, predictive and highlight any potential risks and troubles that could occur down the line
There’s no reason why banks can’t play a larger role in helping their customers achieve financial wellness. The goal should be to provide relevant and consistent guidance and recommendations that are meaningful to customers — delivering advice at the right time as they move through their different life cycles.
Is Embedded Finance the Next New Thing for Banks?
Chances are that many of your customers tip on Twitch, shop on Instagram and send gifts on TikTok. It’s all part of the explosion in embedded finance that has taken hold since the pandemic started.
Embedded finance, in which a non-financial services company provides credit or payments through an online platform, is expected to course through commerce. Some reports suggest the market will rocket to $136 billion by 2026, up from $43 billion in 2021.
In essence, financial providers are following the consumer in the race to create the shortest journey. Consumers are all too happy to take fewer steps to assess competitive financial products on sites that they regularly engage with rather than start a new journey with a bank. This one-stop shopping approach can be convenient and easy to navigate, particularly for consumers who are pressed for time and looking to simplify their online activity.
Ultimately, the customer will become increasingly accustomed to simplified, holistic, direct, multiproduct experiences. That might mean less direct engagement with a bank app in the future.
Financial institutions should actively consider how they can partner with and integrate into other platforms to boost revenue possibilities and take advantage of the technological and other capabilities already at their customers’ fingertips. Those that don’t may well find themselves falling behind the next wave of consumer finance. With non-banks already carving out pieces of the turf, traditional banking providers need to make sure they can be a part of this emerging ecosystem.