- Non-interest-bearing deposits, a key pillar of commercial banking profitability, are at risk because of higher interest rates and changes in the regulatory environment since the last time rates were this high.
- In response, banks should shore up existing treasury management pricing. Tiered pricing for clients who “pay with deposits” versus cash is another option.
- Should neutral rates stay higher than expected, institutions may consider a more radical rethinking of pricing for payments services.
Non-interest-bearing (NIB) deposits have been one of the pillars of commercial banking profitability in the United States, but a combination of higher interest rates and regulatory changes has put their future at risk.
In 2022, at the start of the latest rising rate cycle, roughly half of all commercial deposits were in non-interest-bearing accounts. Today it’s down to less than a third (Figure 1), according to Curinos’ Commercial Analyzer and we’re frequently asked, “Where’s the floor?” While we can’t say for certain, we do think it could end up meaningfully lower than it is now, and if that’s the case, the structural impact to commercial-banking profitability will be lasting. That’s why bank leaders heading into the strategic planning season should consider the risks and possible outcomes of a lower floor.
Figure 1: Mix of Non-Interest-Bearing and Interest-Bearing Products (All Commercial LOBs)
The migration to interest-bearing from non-interest-bearing continues unabated.
Some quick background: Until 2011, banks in the U. S. could not pay hard-dollar interest on most commercial checking accounts under Regulation Q, so banks introduced earnings credit rates (ECR), which enabled business customers to offset bank fees as indirect interest on their checking deposits. During the 2010s, the zero-rate policy provided little opportunity for companies to earn yield on their cash, so NIB accounts earning ECR represented some of the best returns available.
Today, that’s all changed – higher interest rates have reenergized company treasurers around the discipline of maximizing the value of their cash. This means focusing on getting paid faster, holding onto their money longer and positioning it to earn the highest return. More often than not, that means putting it somewhere other than in a NIB account.
The numbers speak for themselves. The average ECR rate is 81 basis points, which pales next to the average 3.19% rate on a commercial interest checking account and the 4.01% on a commercial MMDA account (Figure 2). Customers that negotiate pricing with their bank can do even better.
Figure 2: Average Rate by Commercial Product (May 2024)
Returns on non-interest-bearing ECR DDAs pale in
comparison to interest-bearing alternatives.
The sizable gap between available market yield and the bank fees offset by ECRs (1% or less of the average checking balance for most customers) is driving the substantial mix shift taking place in commercial deposits. By the end of May, the average commercial book was down this year by 2% overall, but the average ECR portfolio was off 9%.
So back to the earlier question – where’s the floor? Even as the Fed appears to have reached a plateau and back-book repricing has moderated, product rotation is continuing apace. Unlike with a typical rate-based product, banks can’t simply alter the price of ECRs as a way to change behavior – in fact, increasing the ECR rate could well backfire because a commercial customer could then offset a uniform set of fees with lower deposit balances.
To further unpack the situation, let’s consider some of the other reasons companies may leave balances in ECR. One might argue that the remaining balances at risk of transfer are too small for companies to bother moving them, but the reality is that nearly one-third of remaining balances are in accounts of $10 million or more, and most of those balances are in accounts of $25 million or more.
Some balances will likely be very slow to move, including the one-third in accounts of less than $1 million, because the dollar value of optimization is too small to matter. Others earning hard-dollar interest may need to pass that cash along to beneficial owners, which may add unwanted complexity. Then there are those that are simply slow to change.
At Curinos, we believe banks would be well advised to weigh the risk that the total share of commercial balances in NIB products will drop from about a third to somewhere in the mid-20% range. We base this view on continuing cross-product flows, rate differences between ECRs and interest-bearing alternatives and the composition of remaining ECR balances. The downside risk is even steeper if rates normalize closer to current levels than the neutral levels policymakers and market participants currently anticipate.
For a bank with $10 billion in commercial deposits, a mix shift from 33% NIB to 25% NIB at an average interest-bearing rate of 4% would reduce a bank’s net interest income by $32 million annually. Even assuming its customers also pay 1% of their DDA balances in payments-related fees currently offset by ECR, the net impact to earnings would still be $24 million per year.
What can be done? Hoping rates come down quickly would be one answer, but not only is that scenario looking increasingly remote, the first couple of Fed cuts likely won’t move the needle because of the ample spread between interest rates and ECRs. So what else?
First, banks should shore up existing treasury management pricing through robust reviews of standard prices as well as practices around discounting, waivers and exceptions. Best practices include annual reviews of which services are offered, price points relative to market and the impact of relative pricing on customer behavior. For clients with deep discounts or waivers, annual reviews are no longer sufficient. Banks need to know sooner of changes to deposit levels or pricing have pushed the relationship below target profitability hurdles.
Second, banks may want to develop a two-tiered pricing model for clients who “pay with deposits” versus those who require market rates on their cash and need to pay hard dollars for their services. Pricing payments services at slim margins works when the client compensates the bank with fees and non-interest-bearing deposits. But for clients demanding indexed rates to keep funds at the bank, pricing for payments services generally needs to stand on its own.
Such actions may be sufficient in an environment where rates return to +/-3% over the next couple of years and the yield curve normalizes. But in a sustained higher neutral-rate environment, more may be needed. This could include a more radical rethinking of pricing for payments services and much stronger requirements to bundle primary relationship activity with a capital commitment.
Our intent is not to scare, but to caution. If nothing else, the past few years of volatility have reinforced the value of planning for market outcomes that seem unlikely at the time. Remixing from non-interest-bearing into interest-bearing deposits has the potential to confound efforts to translate modestly falling rates into lower bank funding costs. We believe that contingency planning for the possibility of meaningfully fewer non-interest-bearing deposits in commercial portfolios is a prudent exercise.
