- Three sea changes are disrupting the traditional commercial banking business model: the repeal of Reg Q, private credit and the proliferation of tech vendors and APIs.
- To meet the moment, banks will need to rethink where they’ll compete, how they’ll win and how winning in the new commercial market will translate to their financials.
- Increasingly, they’ll have to move from selling commoditized products on price and relationship to selling customized solutions based on expertise and product capabilities.
Lead with credit, and cross-sell deposits and payments services. That’s been the traditional model of commercial banking. The payments services creates frictional cash held in non-interest-bearing DDAs (ECR accounts) that makes those deposits sticky. The spread on the non-interest-bearing deposits turbo-charges the returns on the capital backing the credit. As long as the credits performed, this was a wonderful business model.
But over the past decade and a half, three big changes have disrupted the model, and in today’s normalized interest rate environment, their cumulative effect is hitting home:
First, the repeal of Reg. Q opened the door to product innovation allowing companies to easily earn interest on their checking deposits. This was a hit to the easy spread that banks were used to earning on their commercial operating deposits.
Second, private credit has evolved from a niche player to the driving force in C&I lending. It’s forced banks to compete differently to win primary payments relationships and operating deposits.
Third, a proliferation of technology vendors and APIs has fundamentally changed the nature of being a payments bank, requiring higher levels of industry- specific expertise.
From BAU to Transformation
In a stable market, outperformance is driven by business execution. In a transforming market, outperformance is driven by the speed and skill with which management teams adjust strategy and tactics. Commercial banking is in a transforming market.
The cost of not adapting can be huge. We estimate that the structural disruptors to the traditional commercial banking model combine to produce an 18.75% headwind to the top-line earning potential of a typical middle market commercial relationship. This is driven primarily by tighter risk-adjusted loan spreads on stiffer competition for attractive credits and by reduced net interest margin on deposits (Figure 1). Monetizing payments fees at current levels can close part, but not all, of the gap.
Figure 1: Implications of Changes to Commercial Business Model
To navigate these structural transformations in the market, commercial banking businesses will need to rethink where they’ll compete, how they’ll win and how winning in the new commercial market will translate to the balance sheet and income statement.
Where Will You Compete?
The new commercial baking environment requires thinking about client selection differently. Traditionally, it was driven by a combination of credit appetite and perceived high-growth industries, either within footprint or nationally. Going forward, the commercial business will need to place a greater emphasis on the broader banking needs of various segments, including deposits and payments complexity, as well as the bank’s right to win. Many deposit-rich segments are well known, so just piling in to the same strategy used by others is unlikely to move the needle. But even within traditional C&I verticals, available deposits and payments complexity exhibit big differences where banks can carve out a niche and take an outsized share. (Figure 2).
Figure 2: Estimated Deposit per $1B Loan Commitment
Source; Curinos Analysis
Note: Cash-rich focus defined by top 3 industries with lowest LDR; Credit-intensive focus defined by bottom 3 industries with highest LDR; Non-targeted approach reflects average of other C&I verticals
How Will You Win?
Driving differentiation within targeted customer segments increasingly requires transitioning the sales mindset from selling commoditized products on price and relationship to selling customized solutions based on expertise and product capabilities. That’s because product capabilities increasingly exist not in a vacuum but in an ecosystem. So it’s critical that a salesforce have a deep understanding of the integration of business and technical solutions into the client infrastructure and workflows. Greater partnering between the bank and the client both before the sale and during integration is also critical.
All this requires a different kind of organizational thinking. Traditionally, Relationship Managers have served as coordinators, and sometimes gatekeepers, of the client relationship. With deeper integration into day-to-day business operations, banks should look to elevate the role of payments experts within the relationship. This will remove friction in addressing the client’s non-credit-related business needs and accelerate identification of opportunities to deepen the relationship.
For this to work, banks need to adapt both their organizational structures and their incentives. Scorecards should reflect the transition to a relationship structure that’s more balanced, emphasizing the value of providing expertly structured payments and liquidity solutions. And for banks to generate the earnings required to continue to invest in experts and product enhancements, they’ll need to monetize the value of these solutions more deeply than they have historically. This requires equipping bankers with the tools to dynamically manage the profitability of the relationship across a broad range of services.
What Winning Can Look Like
Banks that successfully undergo this transformation will achieve both faster customer growth and deeper customer relationships. From a proprietary benchmark of banks that Curinos deems market leaders in embedding these concepts, we see significant outperformance in deposits and fees. The difference is most striking when looking at DDA deposits, which are one of the best proxies for relationship primacy. The leading banks delivered 4x the peer average in DDA growth (Figure 3). Achieving these kinds of results requires both a clear view of the competitive dynamics and customer needs and an honest appraisal of the bank’s relative strengths and right to win.
Figure 3: Banks Embedding Transformational Strategic Concepts
Note(s): TM growth calculated using January to December totals for each year | Deposit and DDA growth calculated using December totals for 2024-2019
Source(s): Curinos TM Fee Analyzer, Curinos Commercial Deposit Analyzer
Engaging in a transformational strategic process can equip banks with the confidence to place more concentrated bets on the products and people required to drive differentiation in an increasingly specialized market. Moments of market transformation can be challenging, but they’re also where opportunity can be found. Banks that act now to sharpen the strategic focus within their commercial businesses stand to outpace their competitors.
