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The Moat You Thought You Had? It’s Been Breached

Pandemic. Near-zero rates. Surge deposits. Those were the days. The realm was secure from interlopers – or so it seemed.

Then came the fastest rise to interest rates in 40 years, and thanks to technology and changing consumer preferences and behaviors, the competitors came, too. Only this time, they didn’t need branches, only a digital presence and the will to invest. With alarming speed, the moat – whether real or perceived – was rendered obsolete. How can regionals and smaller banks defend themselves and their profitability now?

Curinos has been analyzing the migration of deposits from physical locations to digital for many years, but spiking rates and the reemergence of CDs, beyond retail to small business and wealth, have transformed the trend into an accelerating assault. We estimate that retail deposits at traditional banks will be down 1% to 3% this year and roughly flat in 2024. Meanwhile, retail deposits at online banks are expected to finish the year up 8% to 10% and another 8% in 2024. Over the same period, the compound annual growth rate in deposits for online providers is expected to be 8%, versus -3% for traditional banks (See Figure 1). Smaller institutions may fare even worse: Those with assets from $10 billion to $50 billion already have lost more than three-quarters of their pandemic-related surge deposits, almost twice the average for the industry overall (See Figure 2). 

Figure 1: Retail Deposit Forecasts

Source: Curinos Analysis | Retail Forecast as of May 2023

Figure 2: Deposit Surge & Runoff By Asset Tier

Source: Showing data from top 137 U.S. Banks based on total assets | Surge Deposits measured as deposit growth from 2020-2022 in excess of median growth rate from 2016-2019

The loss of accounts and volume is bad enough, but the profitability story gets worse when looking at the cost side. Online banks have added CDs to their menu of mostly high-yield savings accounts at introductory rates of 400 basis points (bp) or more. For them, the marginal cost of funds (mCOF) is whatever premium rate they offer plus non-physical marketing expenses.

But an incumbent bank whose territory is under siege needs to protect its book. That means matching rate (or at least coming close), investing in a retention campaign and doing what it can to bring in new money. All in, a rate move from 1% to 4% to attract, say, $500 million in deposits could translate into a 10% to 12% increase in mCOF and put a serious dent in an institution’s profitability.

What Can Be Done?

More than ever, banks need a deposit playbook, or an update to the one they already have. Without the right playbook, they may be raising rates too broadly and unnecessarily repricing their back book. What are some strategies that a playbook could reveal? While the deposits profile of every institution is unique, here are several ways a playbook could broaden options and provide steadier profitability.

Launch a balance-augmentation campaign. Through marketing efforts enabled by personalization engines, banks can target only those customers who are more likely to respond to rate and cash offers. This way, banks can achieve meaningful balances without repricing the back book or going out to the deposit market.

Offer a new-money promotion in thin markets. Promotional new-money rates in regions where market share is low can effectively garner new deposits. At the same time, maintaining a high-yield savings rate that is “good enough” in denser markets can help retain most of the existing book. Focusing on new relationships along with rate can ameliorate the effects of having to reprice.

Create a CD-rollover strategy. Fending off high-rate competitors when CDs are rolling over can get expensive. One component of an integrated strategy could be to offset these losses by offering a high top-rate CD for only new money to put a fence around the offer and limit internal cannibalization.

Adopt an exception-pricing strategy. In this approach, a provider can isolate a subset of its renewing CD base (for example, half the branches or two weeks of renewals in a given month) and test exception pricing among qualifying customer against what it’s offering to the overall base. A variation worth testing: Make the exception contingent on a customer deepening their relationship by opening a transactional account. (Other strategies are presented in another article in this issue of Curinos Review, “Higher Rates Push Banks To Draft A CD Maturity Playbook.”)

Introduce a relationship savings product. These products typically reward higher balances with higher rates. If the bank serves enough customers and prospects who are relatively affluent, such an offering could be worth the investment in time and resources.

Double down on small business. On average, small-business deposits cost about half as much to acquire as consumer deposits. And because the most of these deposits are in non-interest-bearing checking, their portfolio rate is only about 25 bp. But this advantage hasn’t been lost on online banks, so now could be the time to act. (See “Small Businesses Offer A Clear Profitability Upside For Banks” in this issue of Curinos Review.)

Curinos projects that by Q4 2024 deposits with online banks will have increased to 24% of the total $7 trillion deposit mix, up from 19% in Q2 2022 (See Figure 3). Because total deposits are likely to remain flat, that increase of $350 billion is the same amount that traditional banks will lose.

Figure 3: Curinos 2023 & 2024 Consumer Deposit Forecast

Source: Curinos Analysis | Forecast as of Sep 2023

To stanch the flow and protect their bottom line, these providers will need to be more strategic than ever. That means putting strategies in place that are conceived and guided by a well-designed deposit playbook.

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