Treasury teams are likely to focus on how much banks are paying for deposits and the betas associated with them as rates rise. Deposit life, however, is another important and often-overlooked metric that changes through interest rate cycles and has significant implications for growth and profitability.
Indeed, this measure of balance stability has already begun to contract and is expected to shorten even more significantly this year due to higher rates and rising inflation. In addition, deposit life can be shortened by digital advancements that make it easier than ever for customers to find higher rates, open accounts and transfer balances. The result: banks may underestimate their liability sensitivity to rising rates, struggle to hit planned balance growth and overestimate the value of their deposit funding.
Financial-services firms can manage this challenge more easily by improving the foundational deposit study analytics that feed interest rate risk management. This includes analyzing deposits on a segment-by-segment basis rather than as a monolith. The availability of timely information on expected life can play a key role in helping treasury teams navigate these fast-changing industry dynamics.
Figure 1: Trailing 12-Month Personal Savings and Business Savings – Weighted Average Life (WAL)
RATES RISE, CUSTOMERS MOVE
There’s little doubt that the recent rate hikes, combined with expectations for more increases throughout the year, will have a significant impact on deposit duration. The flow of funds between products and financial institutions is expected to accelerate as rates rise and customers increasingly favor higher-earning savings and term deposit products. This includes offerings from a growing number of direct banks that woo consumers and small businesses with competitive interest rates. Among them are a litany of direct banks that launched as online-only businesses of branch-based mid-sized and regional banks.
But it’s not just higher rates that will impact deposits. This time, there’s also inflation that stands at a 40-year high due to COVID-19-related monetary policy, supply-chain disruptions and geopolitical conflict. If persistent inflation has a disproportionate effect on consumer spending compared with wages, the resulting lower savings rate can contribute to shorter deposit life.
Additionally, we expect business and affluent consumer segments to reallocate cash balances away from low-earning deposit accounts.
These behavioral changes have an intuitive effect on expected life — or behavioral life — of deposits that treasury departments monitor as part of routine interest rate risk measurement (and profitability measurement). Generally speaking, longer deposit lives translate to more stable funding that is valued more highly through a funds transfer pricing (FTP) framework or other mechanism of profitability measurement. From an interest rate risk perspective, longer lives mean a less liability-sensitive balance sheet, which translates to margin expansion when rates rise.
DEPOSIT LIFE IS ALREADY CHANGING
The expected lives for both consumer and commercial deposits have already shortened measurably since January 2022, according to data from Curinos Treasury Analyzer. Balance decay analysis of more than $4 trillion in deposit balances captured at the account level in our proprietary Comparative Deposit Analytics (CDA) shows that savings weighted-average lives have shortened by 0.8 years for consumer and by a more impactful 2.1 years for commercial since early in the fourth quarter of 2021. (See Figure 1.)
This shortening, combined with the difference observed across segments, carries several implications. First, it means there may be headwinds to deposit growth that isn’t captured in bank business plans; Curinos estimates there can be as much as 1%-4% higher savings balance outflows based on the above trend. Second, it suggests banks may be less asset-sensitive than expected, implying a less rosy profitability outlook as rates continue to rise. Specifically, banks will have to replace more runoff balances at prevailing market rates, which will naturally increase through the cycle. Third, the funding value of deposits may decline by as much as 25-35 basis points for savings in FTP terms based on weighted average life (WAL).
Differences in the magnitude of shortening observed across segments — in this case the steeper decline seen in business savings WAL — also confirm the general intuition that different segments of deposits have different funding value to banks. This is critical knowledge for strategic business planning, tactical deposit pricing and product
DEPOSIT ANALYTIC IMPROVEMENTS NEEDED
Bank treasury teams must move quickly to improve the foundational deposit study analytic information that feeds interest rate risk management. The two most critical areas of improvements should be:
- Timeliness. Observations from dated deposit studies, “through-the-cycle” observations that over-index to flat-rate environments or observations that are skewed by COVID-19-era stimulus effects (such as idiosyncratic months of massive inflows from stimulus payments) may be highly unrepresentative of current behaviors and lead to suboptimal internal rates of return. In our view, these metrics should be monitored monthly, including at the executive-level balance sheet management committees such as ALCO, and not on an annual basis as is currently the process for many players.
- Customer Segmentation. Overly-aggregated results (those that pool balances from a range of customer types into broad product categories, for example) lead to inaccurate measurement and suboptimal decisions. Curinos believes the most useful deposit studies will segment around customer types, focusing not just across major lines of business, but also on the primacy of customers or clients within each business. This can, for example, capture the behavior of a savings depositor with a direct-deposit activated checking account separately from that of a savings-only depositor. It can also make the distinction between a business with an active treasury management relationship and a business with an inactive relationship.
In an information age where data abound and are available in near real time, critical information around customer deposits — the primary source of funding and arguably the primary driver of shareholder value for the industry — should not be months or years old.
And the stakes are real: the value and stability of deposits — given interest rate and inflationary effects — will be markedly different by the end of the year from where they stand today. Banks that can understand and react to those trends swiftly will have a real competitive and risk management edge.