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Funding Optimization is Crucial as Surge Deposits Linger

Almost a full year into the COVID-19 era, the surge in deposit balances created by a variety of government stimulus and customer behavioral drivers remains intact. Commercial deposit balances, the primary driver of the surge, increased more than 36% since the onset of COVID, with roughly 5% observed in the final quarter of 2020, according to the Novantas Commercial CDA Executive Summary.

With another round of stimulus funds flowing into bank accounts, consumer deposit balances — already up roughly 14% since the onset of COVID-19 — are poised to surge again. As loan growth lags, cash and securities portfolios have ballooned, pressuring asset yields and bank returns during this period of low interest rates. (See Figure 1.)

Banks are making some moves to stem additional inflows and achieve margin relief in inflated investment portfolios, but broader funding optimization decisions are needed. In this age of big data, banks should explore the use of scoring to develop empirically-driven analytics that can be used to value and manage deposit customers on a granular basis.

Figure 1: Deposit Landscape

Total U.S. Domestic Deposits ($T)

% Total Surge by Segment

Commercial Deposit Surge by Quartile

excess deposits vs baseline deposit chart

Total U.S. Domestic Deposits ($T)

excess deposits vs baseline deposit chart

% Total Surge by Segment

Commercial Deposit Surge by Quartile

Source: Novantas Analysis; Novantas Commercial Deposit Analytics; H8 Report

TABLE STAKES: TACTICAL ASSET AND LIABILITY MANAGEMENT

On the asset side, banks have taken some tactical actions through investment portfolio management, deploying balances into longer-duration or higher-coupon securities. Some amount of investment portfolio optimization is needed, but overreliance on this strategy could mean trading marginal incremental yield in the short term for significant value risk in the longer-term if interest rates rise—a risk underscored by recent yield curve steepening, which saw the 2Y to 10Y interest spread reach its highest level in five years. Such strategies may hamper a bank’s ability to meet customer-driven asset growth in the future.

On the liability side, banks are doing what they can to reduce deposit pricing and limit further inflows. A late 2020 Novantas Commercial CDA survey of commercial lines of business found that three-quarters of respondents took active measures to limit additional deposit growth, with 42% paying declining or zero rates on surge balances, and 26% communicating balance limits to clients. Another 21% required additional product purchases in exchange for accommodating surge balances and a not-insignificant 16% of respondents suggested placement of balances at a competitor institution. Unsurprisingly, our survey found that 26% of respondents used funds transfer price reductions to disincentivize or discourage additional surge deposit growth.

REPLACING LCR AS A GUIDEPOST ON VALUE

Greg Muenzen
Director, New York
gmuenzen@novantas.com

Deposit resiliency in stress is a well-known focus of the Liquidity Coverage Ratio (LCR), a regulatory liquidity metric that prescribes 30-day deposit runoff assumptions for a range of predefined, often high-level, deposit segments. Large banks that are subject to LCR often view the measure as a binding constraint for liquidity management and use the assumption to allocate liquidity costs to deposits through funds transfer pricing.

In relying solely on LCR runoff assumptions, however, banks may be overly simplifying deposit liquidity characteristics in two ways. First, banks may be considering too short of a scenario time horizon for liquidity stress. Second, LCR’s one-size-fits-all assumptions — such as the 10% outflow assumption that doesn’t differentiate between branch-based and online savings or the 40% outflow assumption that treats all commercial non-operational balances the same — lack useful differentiation that banks need to value funding and make customer-level decisions.

REPLACING LCR AS A GUIDEPOST ON VALUE

Greg Muenzen
Director, New York
gmuenzen@novantas.com

Deposit resiliency in stress is a well-known focus of the Liquidity Coverage Ratio (LCR), a regulatory liquidity metric that prescribes 30-day deposit runoff assumptions for a range of predefined, often high-level, deposit segments. Large banks that are subject to LCR often view the measure as a binding constraint for liquidity management and use the assumption to allocate liquidity costs to deposits through funds transfer pricing.

In relying solely on LCR runoff assumptions, however, banks may be overly simplifying deposit liquidity characteristics in two ways. First, banks may be considering too short of a scenario time horizon for liquidity stress. Second, LCR’s one-size-fits-all assumptions — such as the 10% outflow assumption that doesn’t differentiate between branch-based and online savings or the 40% outflow assumption that treats all commercial non-operational balances the same — lack useful differentiation that banks need to value funding and make customer-level decisions.

WHAT TO DO NOW: CUSTOMER SCORING

These tactical asset and liability actions are necessary, but bigger change is needed in the form of broader funding optimization — an imperative in today’s low-rate environment. Banks should be careful that they don’t base such efforts on incomplete views of customer value or high-level regulatory prescriptions, including from LCR. Instead, analytics can include customer-level pricing, cross-sell or myriad other treatments. In our experience, successful scoring initiatives require thoughtful definition of customer value, a big-data approach to customer scoring and a focus on the range of macroeconomic scenarios that could play out in 2021 and beyond. The ultimate goal: identify the deposits that you want to keep.

IDENTIFY VALUE EXCHANGE

Standard Treasury frameworks for deposit valuation focus on the interest sensitivity and liquidity characteristics of deposits. Long-term stability, price insensitivity and balance resiliency in stressed environments are pillars of deposit value. (See sidebar.) While appropriate for Treasury-oriented balance sheet management and funds transfer pricing applications, this view of balances ignores other, more customer-centric drivers of value, such as fee revenue potential, cross-sell potential and acquisition cost advantages. The ideal customer scoring methodology recognizes both funding- and customer-centric drivers of value.

The accuracy and usefulness of customer scores will increase with higher-quality input data describing the customer relationship with the bank. In addition to customer demographic and product holding data, transaction-level data (including Treasury Management data for commercial depositors) provide highly relevant insights into customer primacy, which typically tracks closely with customer value. This will enable the bank to consider using incentives and rewards to retain valuable deposits, while discouraging those deposits that aren’t worth keeping.

ONGOING EXERCISE

Depositor behaviors from everyday consumer savings rates to large corporate cash management changed suddenly and materially at the outset of COVID-19. Therefore, it stands to reason that behaviors may change again as the economy improves with vaccine rollouts or potentially stalls again. As such, the attractiveness of various deposit segments will change. The ideal customer scoring methodology will control for these macro effects, thus enabling scenario analysis.

The persistence of flat rates, surge deposits and tepid loan growth will increase the need for funding optimization efforts — and tough decisions in terms of prioritizing and de-prioritizing customer growth. Banks need empirical tools to guide these decisions, weighing a range of scenarios given the unpredictability of today’s economy.

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