Elasticity measures deposit demand as a function of a banking institution’s pricing position relative to that of its competition. If deposit pricing doesn’t rise to meet demand, some deposits will attrite and the ability to acquire new accounts will evaporate. Conversely, if pricing stays with demand, there’s opportunity to pick up balances, most likely from price-sensitive segments. The middle ground is the area of indifference or “no man’s land,” which, relative to today’s environment, has generally been narrow and predictable. (See Figure 1.) This is the essence of price elasticity.
Figure 1: Typical Price Elasticity Of Demand
But, the current area now exceeds 300 basis points, which is massive compared to previous rate cycles. This has been caused by the unprecedented spread between front book and the back book rates, which will lead to significant repricing. Without knowledge of the price-response relationship, financial institutions can be exposed to typical pricing pitfalls, such as:
- Reacting too quickly to perceived actions of competitors
- Not recognizing differences in products, segments, and regions
- Failing to reinforce desired pricing activity and behaviors at the front line
- Focusing only on acquiring balances, not full balance flows and repricing risk
Acquisition balances are the most elastic while existing balances are far less elastic. While these relative levels of elasticity may be known, without implementing back-book models in tandem with the acquisition models, financial institutions will be unable to balance the new-to-bank dollars with the repricing exposure of the existing balances.
One thing is clear: None of this analysis is possible without analytically driven decision-making. And that requires that an institution arm itself with near-real-time data on customer behavior and competitive activity.
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