Wealth customers are already responding to rising rates differently than they have in previous cycles, raising the stakes for financial institutions to better understand the ways in which these valuable customers behave.
In contrast to the last rising-rate cycle in 2016-19, wealth deposits are moving quickly and with purpose. Balances are running off rapidly, affecting private bank checking, money market deposit accounts (MMDA) and cash sweep balances. (See Figure 1.) Betas are also increasing as banks try to keep deposits on balance sheets by offering competitive rates on deposit products at a time when money market mutual fund (MMMF) yields have surged past 2.00%. This behavior is in stark contrast to mass-market customers who have been slow to respond to the new environment.
As competition intensifies for wealth deposits, banks need to create more precise products aimed at these sophisticated customers. Wealth customers, perhaps because of their additional investment options, tend to have different needs than mass-market consumers and often very different degrees of elasticity. Understanding the complicated needs of wealth customers creates opportunities for properly priced and appropriate value propositions that can retain customers without resorting to blanket rate offerings.
Figure 1: Checking Growth by Quarter by Segment
Tracking Rates Closely
While the average retail customer likely isnu2019t closely attuned to actions taken by central banks, wealthier depositors u2014 or specifically, their financial advisors u2014 pay much closer attention. As the Federal Reserve increased the target for the Federal Funds rate by 2.00% over four months earlier this year, for example, sophisticated depositors expected the higher yield to be passed along for their benefit. As with commercial customers, a financial professional can identify meaningful yield on the cash portion of the portfolio – providing them an easy, value-added win with their wealth customers. If a bank or brokerage wonu2019t pay the rate on a deposit, the yield can be found elsewhere.
This rate cycle is very different than the last. The lag in rate increases for wealth customers was more pronounced at the start of the last cycle, both because of the slow pace of Fed movements and also because of the nearly 10-year low-rate environment that preceded it. For a long period of time, investors didnu2019t think of the cash portion of their wallet as providing yield. This cycle has seen near historical rapid rate increases. The opportunity to reclaim yield is top of mind, especially with inflation and market volatility putting pressure on returns elsewhere.
Needs Categories For Cash
Curinos has previously examined the ways in which consumers segregate their cash based on needs of u201ctoday,u201d u201ctomorrowu201d and u201csomeday.u201d Consumers held cash for monthly use (u201ctodayu201d), as a cushion for potential near term demands or needs (u201ctomorrowu201d) and for longer term security and retirement (u201csomedayu201d). The longer term the need, the more elastic the price. When rates were low for a long period of time after the global financial crisis, these needs were largely bucketed together and forgotten about. With yields often under 0.10%, there was little imperative to seek returns. Therefore, many investors allowed significant portions of their cash to co-mingle in a small number of accounts. These accounts often served multiple purposes, with typically rate-sensitive u201ctomorrowu201d and u201csomedayu201d money sitting in checking and sweep accounts because yield-bearing alternatives didnu2019t offer a rate advantage. (See Figure 2.) As rates rise, the naturally rate-sensitive portions of cash in these pools are migrating to products that offer a more attractive rate.
The undoing of this co-mingling of cash began in the prior rate environment, but never finished. With the Fed reducing rates in 2019 even before the pandemic took hold, yields reached sufficient levels to drive significant shifts in balances. But checking and cash balances remain elevated in many accounts. These shifts are beginning more rapidly in this cycle, continuing to undo the co-mingling.
Figure 2: Three Distinct Pools of Cash
Deciding When To Raise Rates
Even with the pressures and faster pace of rate hikes, why are some institutions moving far more rapidly and aggressively than in the past? Competitive dynamics and behavioral economics allow for some advantages of moving earlier rather than later. (See Figure 3.)
With the Fed widely forecast to increase rates above 3.50% by the end of 2022, the rate required to dislodge an ultimately rate-seeking deposit is lower now than it will be later. Even a rate in excess of the Fed Funds target and MMMF yields will return to profitability later in the cycle, assuming the Fed continues its upward momentum. This may also allow institutions to retain the rate-seeking portion of cash in deposits rather than allowing them to escape to off-balance sheet fixed income. And it allows for a leg up, even over other deposit-taking competitors.
Additionally, retaining deposits is nearly always less expensive than reacquiring deposits later in the cycle. In order to dislodge a customer who has moved to MMMF or brokered CDs, that customer will require a rate in excess of those alternatives and a promise to keep pace with near-100% beta instruments.
With rates moving rapidly, many institutions have seen the writing on the wall and are incentivizing customers to move. If a pool of cash will ultimately be rate-seeking, does your institution prefer to keep the cash on balance sheet even if it means an 80%+ beta? Or do liquidity levels allow for rate-seeking funds to move off balance sheet to MMMF or other fixed income alternatives, leaving a smaller pool of deposits, but one that is more stable and at a lower beta?
Either way, understanding the magnitude of competitive behaviors and balance dynamics across the industry is critical, as is an understanding of the trade-offs between acting early and late u2014 and where the cash may end up. Decisions made now will have long-lasting echoes.