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Rising Rates Are Transforming Commercial Deposit Economics

This Month In Commercial Banking

As rates continue to rise, with seemingly no end in sight, the gap between earnings credit rates (ECR) and those paid on commercial interest-bearing deposits continues to widen. As a result, many bank clients are finding they can earn more by putting their money into interest-bearing demand deposit accounts (IB DDA) and money market demand accounts (MMDA) and paying their treasury management (TM) fees out of pocket. The shift is putting even greater pressure on bank profits.  

Take a hypothetical example of a client with a $20 million loan, $10 million in deposits and $120k in annual TM fees. (See Figure 1.) If it keeps all deposits in ECR, the client earns no interest and pays $43,000 in annual TM fees after being credited with the going rate of 77 bp in earnings credits. If it keeps all deposits in MMDA, on the other hand, it earns $238,000 in interest even after paying its TM fees. If it splits the difference, the client still nets $97,500. Meanwhile, the bank’s return on capital employed (ROCE) across these three scenarios drops from 22% to 18% to 13%.  

Figure 1: Effect Of ECR And Interest-Bearing Deposit Mix On ROCE (Sample Illustration)

Source: Commercial Analyzer ES, Commercial Analyzer, Curinos Analysis ​

To be sure, many factors – some beyond a client’s or bank’s control – contribute to the right mix between non-interest-bearing and interest-bearing accounts. But this example puts in stark relief the dramatic change that is occurring from the years of zero interest rates and the growing need for banks to manage these dynamics actively.  

In the long run, there is perhaps no solution more effective than building a portfolio of primary relationships from the ground up, which will make operating deposits harder to move out of DDA for yield. In the interim, here are three tools that banks can deploy to make improvements on the margin.  

  1. Funding playbook. How clients react to rate hikes can vary significantly. While some will move balances or even their primary provider when rates rise modestly, many more will stay put, for a variety of reasons including their attachment to an institution. A funding playbook can help define these differences by client and inform appropriate actions.
  2. Profitability-management tools. Deposits are only part of the equation. To understand a client’s overall value, an institution needs the tools to assess profitability across the entire relationship. That can help executive management appreciate each client’s relative worth and help the front line know how to deal with the bank’s clients more effectively.
  3. Treasury management pricing event. Recent Curinos research reveals that most clients, even those who receive fee hikes regularly, are not deterred by fair increases for commensurate value. While these increases may not offset all rising funding costs, they can both soften the impact and help lock down more ECR DDA deposits.  

Taken together, these tools will help bankers optimize their decision making at the customer level, which in turn will improve profitability while their longer-term strategies play out. 

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