We begin this month with a Novantas analysis that explores the future for the commercial deposit surge. While we highlight that there are many other scenarios that collectively create a wide cone of uncertainty, we also wanted to state clearly that our expectation is that the commercial deposit surge is here to stay – and that bankers should make plans to manage this assumption.
Next, coming out of our annual State of the Treasury Profession survey, we examine the opportunity banks have to add value to their corporate clients outside the traditional TM offerings.
Finally, we make the case for banks to rethink the cent-per-widget TM pricing model and implement strategic pricing that more closely resembles a fair value exchange.
COMMERCIAL DEPOSITS: STOP TALKING ABOUT SURGE, START PLANNING
Commercial deposits are up more than 30% since March of 2020. In the early days of this surge, many market participants expected a reasonable near-term reversal of the deposit influx. But one year in, balances are still growing and a careful reading of the drivers of that growth suggest elevated deposit levels are here to stay.
There are a range of scenarios that could drive overall deposit levels materially higher or lower, but our expected case scenario is total commercial deposits are broadly re-baselined to current levels. We expect those balances to be redistributed over time, however, as the pandemic rewards some business models and company sizes, while punishing others. As these deposits begin to puddle up in a smaller number of places, they will become more difficult for banks to manage.
The first wave of surge deposits was triggered by a significant uptick in credit line drawdowns in March of 2020. But these were mostly repaid just a couple of months later.
The next phase of the surge coincided with fiscal policy interventions in the CARES Act. To date, just over $750 billion in PPP loans have been approved and funded. How much of that money remains permanently in the money supply depends on how much is ultimately forgiven but to date, the forgiveness rate on applications received has been 99.7%. (See Figure 1.)
Consumer stimulus payments have also contributed to the surge in commercial deposits. When combining three rounds of Economic Impact Payments, adding in above-replacement level unemployment benefits and controlling for reduced consumer expenditures, this creates an additional $500 billion to $750 billion in consumer spending power. And while Novantas research shows that roughly a third of consumers have saved all of these funds, another third have spent all of the stimulus funds received and the final third have spent a part of it. (See Figure 2.) Why is this important? Because the stimulus funds that are spent by consumers ultimately flow into commercial accounts.
Figure 1: PPP Loans Forgiveness Rates
|Total 2020 PPP Volume||$521.2B|
|Amount Not Forgiven||$0.7B|
|Applications Not Yet Reached||$212.1B|
Source: U.S. Small Business Administration – PPP Data
Figure 2: Consumer Stimulus Deposit Runoff
Consumer Checking Deposits
Source: Novantas Comparative Deposit Analytics (CDA) Database, March ‘21 | Simple average used to protect participant anonymity
But the most important driver of commercial deposit growth has come in the form of Fed asset purchases and ultra-low rates. During the initial period of market disruption in the early days of the pandemic, the Fed unleashed a tidal wave of liquidity into the market. Between March 2, 2020 and June 8, 2020, the Fed balance sheet grew from $4.2 trillion to $7.2 trillion. Since then, the Fed has settled into a pattern of purchasing an additional $120 billion in assets per month ($80 billion in U.S. Treasuries and $40 billion in Agency MBS).
In total, the Fed has added to the System Open Market Account (or, put simply, created) approximately $3.6 trillion in net new liquidity since the start of the pandemic. (See Figure 3.) Importantly, while the exact timing of Fed asset purchase tapering is unknown, few expect a material slow down before 2022.
In summary, the key driver of the surge was a wave of liquidity created through a combination of fiscal stimulus and monetary accommodation, primarily accomplished through large scale asset purchases by the Fed.
Figure 3: Total Fed Assets
Source: Federal Reserve – Balance Sheet Trends
(and Why It Doesn’t Make Much Of A Difference)
Just as the surge is largely a product of extraordinary fiscal and monetary policy, a large-scale reversal of the surge would likely require the same. There are behavioral factors that can have an impact on the margins (more hiring, an increase in capital expenditures, a shift in the mix of cash deposits versus investments on individual and commercial balance sheets). But the most important driver is the increase in money supply. We should note up front that there are a range of other potential scenarios, including greater-than-expected inflation, economic growth well above historical norms coincident with a marked increase in nominal leverage, really significant changes in behavior, reallocation of foreign currency reserves and unexpected policy or health outcomes.
For the purposes of this article, we will focus primarily on an expected case scenario, but banks should consider additional scenarios that create a cone of uncertainty around future total deposit levels.
With respect to monetary policy, the Fed has generally pointed to the 2013/2014 QE tapering playbook as a guide for unwinding this most recent round of extraordinary monetary support. If we take the past as a guide, we know that it is a slow and difficult process to reduce the size of the Fed balance sheet. The last time the Fed undertook the exercise, it reduced total assets from a peak of approximately $4.5 trillion in January 2015 to a low of approximately $3.8 trillion in August 2019. This amounted to roughly a 17% reduction in overall balance sheet size, representing 21% of the balance sheet growth related to the 2008/2009 global financial crisis response. As a point of context, commercial deposit levels remained flat to slightly up throughout the prior period of monetary tightening/partial QE unwind. (See Figure 4.)
Figure 4: Total Assets of the Federal Reserve
Source: Federal Reserve – Balance Sheet Trends
With respect to fiscal policy, the big question in terms of overall levels of commercial deposits is whether the government actually plans to undertake fiscal tightening. In other words, will the government enact a policy of spending less than it collects in taxes and using the difference to pay down the debt? We’re not in the business of political prognostication, but this is not a fact pattern we have seen often in the U.S. Would a corporate tax hike change this assessment? In short, provided the government uses the tax proceeds to fund new spending, it wouldn’t.
With respect to behavioral drivers, capital spending would ultimately be largely neutral to total commercial deposit levels even if the velocity of fund movements between accounts increases. An acceleration in the pace of hiring would transfer funds from commercial accounts to consumer accounts in the near-term, but ultimately the vast majority of that money would circulate back to commercial accounts – barring a dramatic deviation from long-term personal savings rates that are typically in the mid-single digits. Net-net, behavioral drivers are unlikely to move the needle significantly in the long run.
Even assuming a robust economic recovery, it will take banks a long time and a lot of capital to lend through the surplus of deposit on their balance sheets. In short, our expected case scenario suggests we’re in for an extended period of flush liquidity and ultra-low short rates. Banks should take a range of actions to manage through this challenging environment.
As we have often noted, it is also more important than ever to allocate balance sheet capacity and interest expense to primary clients. Deepening primacy drives fee income growth in the near term and creates a stickier lower beta commercial deposit base on a through-the-cycle basis.
Lastly, while it’s essential to develop a forecast, these are unprecedented times and the level of uncertainty around the future course of deposits is higher than normal. The need for extra care and creativity around alternative scenarios cannot be underestimated.
Time to Start Fishing in Bigger Ponds
Over the last several months, we have stressed the continuing challenges around the treasury management business. These include a decade of slow growth (around 3%), fierce competition (with the Big Six TM banks leveraging their scale to a significant advantage), the expansion of offerings from fintech, limited innovation and services that are mostly undifferentiated. Novantas believes it is time to take a step back and challenge the industry’s current definition of the market and find a bigger sandbox to play in!
Traditional TM is a relatively small market in which more than 2,000 banks compete, with an estimated $20 billion in annual revenue. Many banks have expanded their scope of capabilities to include the extended value chain/cash flow management services that are estimated at $500 billion.
While not all these services are in a bank’s sweet spot (e.g., ERP platforms), if even 50% can be targeted, we are talking an opportunity that is 10x the current traditional market.
Novantas believes the truly innovative institutions will target an even more significant market – one that is focused on improving the business performance of the bank’s clients by calling on different parts of the company. This could include sales and marketing with lead lists/ customer treatments and reaching out to the CIO about security benchmarks and best practices. (See Figure 5.)
Figure 5: Markets for Transaction Services
Source: Novantas Analysis
To further bolster the value in this strategy, respondents in our recent annual State of the Treasury Profession survey expressed strong interest in banks providing “non-traditional” services to make their businesses better. (The written survey included 50 companies and interviews were conducted with another 30 executives. Participants ranged from $100M in revenue to >$1B across all the major industry segments.)
The opportunities fall into four primary areas:
- Technology & Tools: Almost 60% of the companies represented in the survey said they were looking for their banks to augment current technology platforms and tools. The most significant need is real-time cash forecasting, but other bank opportunities exist around security and risk management.
- Marketing Analytics and Insights: About one-third of the companies are looking for help in this area. Banks can leverage their large consumer and commercial databases/transaction systems to monetize data for lead lists, best practices and performance benchmarks, boosting a client’s revenue growth.
- Business Process Outsourcing: For many processes and activities, companies just don’t have the scale to execute efficiently. Prime examples where banks have the expertise and scale to apply technology and data include customer underwriting, risk management and collections.
- Ecosystem Development: We define this as an integrated network of trusted providers with a single interface. An obvious opportunity is around risk management with the bank integrating services across security, legal, technology and insurance.
The good news is that this extension of offerings is consistent with the trusted advisor partnership that banks and their corporate customers desire. In addition to core domain expertise, banks have been implementing much of the needed infrastructure to deliver on these opportunities (APIs, customer portals, big data environments). The greater the integration, the stickier the service. Now is the time to be bolder, redefine target markets and leverage one’s strengths in new ways that provide value to the clients and create fee revenue to the bank.
THE NEED FOR A TM PRICING OVERHAUL
As competitive pressures on commercial banks intensify, client experience has emerged as an important differentiator. Many banks have plowed investment dollars into client-facing and back-end systems to better streamline products, improve reporting and enable customization for clients. Others have focused on digitizing the onboarding process and increasing self-service functionality. What remains relatively untouched and increasingly outdated, however, is the way in which banks price treasury management services.
An overhaul of pricing should be a priority for treasury management this year as corporates plan for post-pandemic operations. This overhaul starts by rationalizing price points to simplify current pricing structures. After that, each commercial bank needs to analyze the needs of their clients so they can be addressed in alternate pricing models.
While pricing is typically not a core element of client experience, the unwieldy and intensely complicated treasury management pricing structures at most banks are a major pain point for corporates. Treasury management grew out of complex, customized and manual processing for very large clients. For banks, detailed pricing was a good hedge against not getting paid for the full scope of work. But even as treasury management services have standardized, digitized and moved down-market, pricing has remained just as complex. This complexity has been a consistent obstacle against a fair value exchange between banks and their clients.
This cumbersome approach to pricing leads to a poor client experience. Treasury management billing statements easily have more than 100 different line items – often with poorly-worded descriptions that make it extremely difficult for corporates to understand the value of what they’re paying for – or if the pricing is fair. Corporates also struggle to project fees for budgeting purposes or understand past fluctuations. Finally, industry standardization of services is spotty at best, which makes benchmarking prices and services across banks near impossible and re-bidding services a major effort.
As a result, treasury management pricing is an albatross for many banks to manage and optimize. According to a Novantas analysis, the average regional bank has more than 500 treasury management service codes and manages at least 20 price lists. This results in thousands of individual price points to manage at each bank.
An overhaul of pricing should be a priority for treasury management this year as corporates plan for post-pandemic operations.
Our analysis of a typical bank shows that most fees are concentrated in only a handful of very common services with the Deposit Administration Fee (“DAF”) often accounting for 15% or more. Most banks have hundreds of service codes that collectively don’t account for 10% of treasury management fees. (See Figure 6.)
Figure 6: Concentration of Actual PxV
Source: Proprietary Novantas Analysis
Note: Case Study
Both corporates and banks would benefit from simplified treasury management pricing. It would result in less time and costs to manage and analyze pricing. For corporates, it would make the process of budgeting for banking fees much easier, stabilize fees to a greater extent, enable fee comparisons across banks and build a better internal understanding of the value that treasury management services bring to the organization. For banks, simplification would enable more dynamic pricing tactics and campaigns, support product structures to deepen engagement and potentially decrease attrition. Ultimately, simplified pricing creates a fair value exchange – clients paying a fair price for the value of the services they receive.
But simplifying pricing is just the first step towards a better client experience. The time is ripe for disruption and commercial banks can deploy alternate pricing models to better align value between corporates and banks. (See Figure 7.)
Figure 7: With the right segmentation and strong infrastructure, banks can deploy multiple models to optimize alignment with segment needs and behaviors.
Source: Novantas Analysis
Moving toward an alternate pricing model will pose significant challenges to established commercial banks, but they can also benefit from the inefficiencies from overly complex pricing. New entrants like fintechs that are acquiring commercial banks or banking charters will be far more willing and able to adopt alternate pricing models, making it critical for traditional banks to adapt.