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Commercial Deposits – The Trillion Dollar Risk

As rates rise, a decade of growth in Commercial deposit balances could unwind. To retain and grow deposits in what will be a highly competitive environment requires new, more surgical approaches to pricing.

Today, despite four interest rate hikes, banks’ NIMs continue to be sluggish as intense competition for good loans compresses yields. This makes the cost of deposits the key driver of NIM, and banks are trying to keep deposit rates low even as interest rates continue to rise. Commercial deposits have grown at a much faster rate than loans over the past decade, and have provided a base of low cost funding for banks. As rates rise, Novantas expects as much as $1T of deposits currently parked in Commercial DDA and MMDA to leave bank deposits, seeking higher yields from other short-term instruments (notwithstanding any regulatory impact to Prime Funds). This attrition will put further pressure on both bank funding and NIMs. Going forward, banks need to be selective in who they target and analytical in how they price these deposits for acquisition and retention.

Sizing the Risk
Total Corporate liquidity in the decade from 2007 to 2017 grew by an estimated 20%. Commercial deposits, on the other hand, grew over 80% or $1.3T. Clearly, Commercial customers shifted money out of short-term investments and money market funds into bank deposits (Figure 1: Total Growth 2007 — 2017, Deposit Balances / Loans Outstanding).

The net effect is that Commercial customers nearly doubled the amount of their liquidity held in bank deposits during this time, increasing from 30% in 2007 to 55% in 2016 (Figure 2: Commercial Deposits as % of Total Commercial Liquidity, 1999 — 2017 vs. FF Rates).

This shift was driven by two factors: first, a flight to safety in uncertain times for both the financial markets and the overall economy; and second, the relatively low overall rates available in the industry (Commercial deposit rates were somewhat higher than other short-term investments).

The question is not whether funds will flow again to higher yielding cash instruments, but how much of the $1.3T surge in deposits is permanent and can be retained at acceptable rates (i.e. at or below the historical betas of about 30%-50%). We estimate that as much as $1T of the $3T of Corporate deposits are at risk.

The challenge for banks is to find the right balance between deposit attrition and increased costs to meet funding needs at acceptable betas. The only way for banks to manage this impending change is to be much more scientific in how they target and price deposits. In the short-term, banks need to transform their rate-based deposit pricing capabilities by incorporating more advanced behavioral analytics into pricing/negotiating decisions. And for the long-term health of the Corporate deposit book, banks must up their game on capturing the right targeted operating accounts and balances.

Behavioral-Based Deposit Pricing
The biggest challenge banks face in pricing deposits is the inability to estimate customer rate sensitivity. After an unprecedented long period of low, stable interest rates, banks do not have the experience, the data or the capabilities to analyze how customers respond to rate changes. Banks also lack business intelligence to systematically track competitor rate offers and how customers have responded to them. This lack of data and tools is compounded by the fact that most deposit rates, for the first time in history, are largely negotiated. Novantas’s Quarterly U.S. Commercial Deposit Study found that banks are exception pricing up to 60% of deposits. Posted prices are now a minority. Given the lack of a scientific approach to such pricing, banks are effectively guessing at what a client is likely to accept, certainly not a defensible approach to price realization.

In our pricing work with the industry, we have defined three actions needed to transform Commercial deposit pricing: 1) deploy advanced customer analytics to empirically define value; 2) refine customer segmentation to align rates to value; and, 3) automate sales tools and performance metrics (Figure 3: Three Critical Steps for Commercial Deposit Transformation).

Combining these steps can easily drive an improvement in interest expense by 5-10 bps in today’s rate environment.

The Long Term Corporate Deposit Solution—Growing Operating Accounts
The best long-term source of low cost deposits is customer operating accounts. As competition intensifies for deposits—and especially for the best, most valuable deposits—banks must be much more focused on which customers to target and what part of their cash management needs to target. This is essentially a segmentation and focusing effort on the pools of high value deposits. For example, it is more valuable to capture disbursement accounts than concentration accounts since customers tend to move concentrated balances quickly out to disbursement accounts where they sit. Similarly, given the credit linked sale of TM services, targeting deposit rich (if not deposit only) customers with knowledgeable sales staff and tailored products may help win over historically underserved segments. Recent Novantas research suggests that there are very heterogeneous deposit needs in the marketplace, which creates an opportunity to focus and differentiate cash management solutions.

In the end, a balanced approach to pricing rate sensitive balances and growing operating balances is crucial to long term success. Of course, the pressures applied to the Corporate bank for deposits need to be balanced with the sources from other parts of the bank—retail, small business, wholesale, etc. But no matter what the target assigned to the Corporate bank, the industry needs to evolve to a more sophisticated management of the Corporate
deposit book.

Chrystal Pozin
Director, Chicago

For more information, contact Novantas Marketing

+1 (212) 953-4444

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