The outlook for deposits should be at the top of bankers’ minds following the Bank of Canada’s recent rate hike, which represented its fourth — and a cumulative 100 bp — move in the past year. Novantas believes the action represents an inflection point that shifts the industry into a new regime in deposit behaviour and pricing. Based on lessons learned from the last rate cycle, recent rate trends, and data from the United States, Novantas has developed a forecast for the Canadian deposit market. The results suggest that bankers should prepare for a more volatile and complex deposit market with each successive BoC move. In addition, the recent slow rise in deposit betas (see sidebar below) is expected to accelerate as the central bank pursues future hikes.
As a result, banks that aren’t prepared risk deposit attrition, unanticipated remixing and/or higher-than-expected cost of deposits. As we move into the second 100 bp of the rising-rate environment, bankers need to be prepared with proactive plans and tools to navigate a more volatile landscape.
By Greg Muenzen | Director, New York | firstname.lastname@example.org
Deposit beta is a fundamental measure of the interest-rate sensitivity of a deposit portfolio. Mechanically speaking, beta is traditionally defined as the change in a deposit rate that results from a change in an underlying reference rate—such as the 3-month LIBOR or the Bank of Canada Overnight rate. A beta of 60% implies that for a 100bp increase in a reference rate, deposit rates will increase 60bp. Betas can (and should) be calculated on a granular basis for both acquisition and portfolio rates—critical metrics for pricing and treasury activities, respectively.
Recent investments in deposit analytics have produced a meaningful advancement in the science behind beta calculations. As a result, leading practitioners are leveraging forward-looking econometric models to forecast deposit betas. Techniques range from simple, single-tenor ordinary least squares estimation methods to more advanced methods that include multi-tenor models, models featuring lags or moving averages of market interest rates. Another approach is error-correction modeling that accounts for short-term effects and longer-term structural relationships between deposit rates and market interest rates.
As beta modeling advances, the concept of a single static beta for a deposit segment is being challenged. Instead, experts recognize that betas depend on the path of interest rates (in terms of speed and magnitude of increases), as well as the level of pricing competition in the market — and of course, the bank’s demand for funding.
RATES PAID ON SAVINGS ARE RISING
The acquisition rate paid on personal savings accounts has steadily risen during the last year in tandem with each increase of the target overnight rate. To understand how betas have evolved so far and gauge how they will evolve with additional rate hikes, Novantas examined how much banks paid for acquisitions. Between 12/31/2016 and 7/27/2018, the average acquisition rate paid on savings moved from 48bp to 69bp, representing a beta of approximately 25% (Figure 1). Movements in rates paid on personal savings were seen with every movement of the overnight target rate, with betas increasing with each of the first three 25bp movements.
WHERE DO RATES AND BETAS GO FROM HERE?
Is history poised to repeat itself? Data from the previous rate cycle in 2004-2006 show personal savings acquisition betas were 25% for the first 100bp increase, a rise that is in line with the current cycle (Figure 2). But bankers shouldn’t believe that they will stay this low. Because of the positive convexity associated with deposits, it is expected that betas will increase during the next 100bp increase. An examination of the 2004-2006 cycle data for personal savings accounts found that Canadian banks experienced an average 39% beta during the second 100bp rise. Such a move demonstrates how quickly consumers can react to changing rates.
Data from the current cycle in the U.S. also show betas are much lower during initial rate hikes, but quickly gain momentum during subsequent rate hikes. During the first 75bp raise in the most recent rate cycle from Dec. 2015 through March 2017, U.S. banks above $50B and direct banks only saw a 14% beta for acquisition savings. That rose to 52% during the second 100bp rate increase between June 2017 and June 2018.
WHAT DOES THIS MEAN FOR MY BANK?
Of course, the analysis of general trends doesn’t account for the different types of banks that operate in the Canadian market. Indeed, all banks have unique strategies and needs, with assorted customer profiles and geographic footprints. To understand how an increase in rates affects each type of bank uniquely, Novantas segmented the 2004-2006 data into three distinct categories of Canadian banks: Big 5, Direct, and Other. During the first 100bp raise, the Big 5 banks experienced the largest personal savings acquisition beta of 27%, while the Other category and Direct banks experienced 0% and 19% betas, respectively. During the second 100bp raise, however, the Big 5 saw their betas increase to 30%, Direct banks saw their betas increase to 55%, and Other banks rose to 54% (Figure 3). This sharp contrast displays the unique customer preferences inherent in each type of bank, as well as the different strategies deployed by each type of bank for communicating rates.
By Michael Jordan | Principal, New York | email@example.com
A slow revival of interest in Guaranteed Investment Certificates (GICs) will likely accelerate in the coming year as consumers seek to take advantage of rising rates.
Novantas estimates that the percentage of personal, non-registered deposits in GICs could rise as high as 37% by the end of 2019, up from a current level of slightly more than 32%. The estimates are based on a proprietary model that incorporates longer-term and shorter-term interest rates, along with economic variables that help determine how quickly consumers may move their funds.
The estimate of 37% is based on the prospect of three additional rate increases through 2019; such a move has occurred in the past. The proprietary model also may be used as inputs into balance volume and spread calculations for PPNR, interest rate risk, and business planning applications.
GIC deposits hit a historic low of 31% in August 2017 due to a lack of interest from consumers who found that the additional term premium yield wasn’t enough in a low-rate environment. Despite the recent increase, current allocations still stand well below the traditional rate of about 50%.
U.S. banks are experiencing a similar move toward CDs, which are being offered to consumers in aggressive promotions. As the U.S. has already experienced seven rate increases, these trends provide insight as to what may be in the future for Canadian bankers.
Bank executives should pay close attention to their GIC portfolios in coming months as the anticipated shifts will be critical in assessing interest-rate risk and business plans.
Banks face tough decisions on how to effectively manage a rising-rate scenario that hasn’t been seen in more than a decade; some bankers have never experienced rising rates at all. As a result, many institutions tend to play defense: observing the market and reacting to it. Novantas has found that banks are better served by playing offense: preparing actions and strategies that they can invoke to grow deposits and manage liquidity while preserving margins. Such strategies must be considered as bankers prepare for the central bank’s next meeting in September:
- Proactive funding plan. Being dynamic with acquisition strategies is key to profitable deposit growth in this rate environment, at the business and enterprise level. Understanding the nuances of each strategy, and when to use each tool, is a necessity. Strategies that worked during the low-rate environment mightn’t succeed in the next 100bp raise. For example, the relative price elasticity between savings and term deposits changes as rates rise, while repricing becomes more expensive as the price differential naturally increases. Banks should leverage econometric modeling (incorporating rates and macroeconomic factors) that are used for stress testing to improve forecasting capabilities
- Customer Treatments. Different types of banks have unique customer bases, but even within a bank, customer segments have differing behaviours, sensitivities and product preferences. Novantas previously has stressed that banks should pair traditional promotional practices with a test-and-learn approach when introducing new products and rate incentives. This combined approach allows for banks to quantify motivations behind each customer segment, optimizing balance retention, and overall deposit profitability.
- New Savings Propositions. As regulators increasingly focus on the net stability of underlying funds as well as their liquidity coverage, it is no surprise that the demand for high quality retail deposits has increased. Non-traditional players are now competing for this limited supply of valuable funding. A bank should develop agile capabilities, and explore alternative savings products, value propositions and digital offerings.
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