In late February 2023, Curinos was asked to spend 15 minutes presenting to a group of CEOs about the state of the U.S. deposit market. Because of some pesky quantitative tightening-driven balance declines and accelerating betas, the group was reacting to a funding market that looked much different than the pandemic-era baseline of bottomless cheap funding. “Keep it simple!” warned the conference chair, these are CEOs, not analytical wonks.
Fast forward to today, June 2023. Curinos was asked to participate in a 90-minute in-depth discussion with a roomful of engaged CEOs that had spent the better part of the quarter immersed in the most critical and granular elements of daily deposit management. Detailed deposit terminology was now part of the vocabulary and simplicity was off the table. What a difference a few months can make!
Deposit-portfolio and broader market fundamentals had been in place long before Silicon Valley Bank (SVB) was taken into receivership on that March weekend. After a couple years of excessive pandemic growth, deposit balances were declining, especially those in commercial and wealth. Increasing Fed rates had already created a yawning 400+ basis point gap between the portfolio rate paid on most deposits and the promotional rate paid to attract new ones. And because customer behaviors were becoming increasingly digital and real-time, balances were susceptible to much faster and more significant swings. (See Figure 1.)
Figure 1: Retail Savings/MMDA Rates
As the SVB situation unfolded, it became clear that prior beliefs about bank runs were about as modern as the slide rule. As the result of a Tweet or two, worst-case assumptions about the proportion of deposits that could leave a bank in a 30-day window were shredded in hours, if that. As Signature Bank NY was also taken into receivership over the weekend and bank stocks tumbled, headline after headline predicted the collapse of the U.S. regional banking model. No prognostication was too dire to make it to the front page. (See Figure 2.)
Figure 2: Regulatory Views of Short-Term Liquidity
Liquidity Cover Ratio (LCR) Prescribed Short-Term (30-Day) Runoff Assumptions
But the liquidity portion of this event ended almost as fast as it began. ChatGPT may have been slow to predict it, as were the delayed and trailing indicators of official reporting, but to bankers on the ground it was clear that they got out of the thicket relatively quickly, at least for now.
The lesson learned is that financial institutions (FIs) need to ensure that they’re not on the receiving end of a contagious freak-out, in the form of a named idiosyncratic event that takes them out. But the task now turns to fundamentals: They also need to confront and tackle the challenge of thinner profitability driven largely by scarcity of deposits and increasing deposit costs.
Even heading into a tumultuous year, banking profitability faced challenges, with net interest margin (NIM) having peaked in fourth quarter 2022. Now, with NIM declining, credit being carefully allocated and the industry facing potential new regulations and increased costs from the Deposit Insurance Fund, FIs increasingly risk that their average ROEs will approach their cost of capital. Those below the average may face some even rougher sledding.
Relationships Can Drive Success
So in an environment in which hot money has become even hotter, what steps can FI executives take to succeed in this profitability-challenged environment? Curinos believes these three focus areas, all of which are founded on the importance of customer relationships in any banking line of business. Founded on the importance of customer relationships in any banking line of business, FI executives should be asking themselves the following questions:
- Confirmation of the customer-growth strategy. Who are our target customers, how will we find them, and what value proposition will we use to attract them? Can we trade off interest expense and the cannibalization costs that may result with more cost effective marketing? Are any changes needed to our pre-SVB views?
- Confirmation of balance sheet strategy. Does our customer-growth strategy achieve the balance sheet and income goals that we aspire to? Do any details of our performance measurement system (e.g., FTP) require adjustment given the balance sheet strategy we select?
- Investment in precision analytics that foster success when margins are thin. Are there areas where targeted advancements in analytics can help us be more precise in our targeting, our pricing or our management?
(See Figure 3.)
Figure 3: From a Focus on Liquidity to Profitability
In consumer banking, the recent events have shown that deposits and relationships continue to be stable. Fortunately, even a disruption this jarring didn’t materially alter consumer behavior. While many consumers expressed an interest in moving funds or accounts as SVB unfolded, very few followed through. Instead, consumer activity post-SVB looked remarkably similar to consumer activity pre-SVB, with a consistent flow of funds from lower-yielding accounts to higher-yielding accounts. There was no significant increase in full account closings.
In wealth, however, the last four months have brought added deposit volatility to an environment that was already stressed. Low cash rates were being challenged by the relatively high available returns on low-risk investments like money market funds. Going forward, success will depend on strong, enduring relationships rather than being seen as a transactional provider that offers neither service nor rate. (See accompanying article in this issue, “Wealth Deposits: Instability Grows. What Does The Future Hold?”)
Small business customers have always valued service and advice. In return, they have rewarded financial institutions with sticky deposit balances, limited deposit rate requests (low betas) and credit at fair spreads tied to their operating accounts. In short, small businesses want a full-relationship bank, and banks want full relationships with small businesses.
In commercial, these are the early innings of relationship building, or rebuilding. The post-March events have created what will likely be an enduring belief among corporate boards, and therefore corporate treasurers, that their banking relationships should be delaminated. If they had three banking relationships in the past, the thinking now is that they need four or five. This will place an intense emphasis on understanding the new reality of the bank stack that companies are trying to create, and optimizing within it. In commercial, primacy is changing, which makes understanding commercial relationships more important than ever. (See accompanying article in this issue, “Commercial Deposits on the Front Line of the Profitability Squeeze.”)
Overall, the path to success for almost every financial institution is to improve the organizational focus on the relationship. If it can make the customer the center of its efforts, winning is not a matter of if, but when.