Banks need to clarify their deposit needs over the next few years and overhaul the metrics, skills and strategies used to drive deposit gathering.
Historically, deposit gathering followed a familiar pattern for Canadian banks: prices were set franchise-wide, creating a closely-followed national market for the largest institutions and a relatively tight band of deposit rates. With most players essentially casting the same nets, advanced pricing skills were not an absolute requisite.
But multiple forces are shaking the picture. Consumers are making much greater use of web and mobile channels to shop for banking products and providers, increasing general price sensitivity and the propensity to switch. Meanwhile disruptive players such as EQ Bank and Zag are making headlines with high-rate offers, influencing customer expectations at major institutions as well.
These digital influences have led to a situation where a handful of Canadian direct banks and smaller financial institutions have used the web to attract outsized public attention for their promotional deposit rates. In turn, the largest banks have felt compelled to quickly match these offers. Where rate promotions were almost non-existent roughly four years ago, now they are prevalent, and as a result far less effective than in the past.
In a market where consumer deposits are relatively concentrated with the major banks, the potential for easy balance growth through promotional rates is fairly limited. Instead of making collective progress, players only succeed in denting each other, and meanwhile rate competition puts downward pressure on interest margins. The situation is exacerbated by the current environment of low rates and consumer lending that far exceeds the base of consumer deposits.
To get off this treadmill, institutions will need a more selective form of promotional pricing strategy — an approach that improves the odds of attracting loyal deposit balances and carries less risk of disturbing the current portfolio of established accounts. The answer is precision targeting, learning to direct rate offers in a more disciplined manner: where needed to attract/retain customers; and to the extent that is financially realistic, given the upside potential for long-term balance retention and the downside potential for cannibalization of current accounts.
Along with improved financial modeling that carefully considers the upside and downside potential of rate promotions for deposits, banks will need a deeper analytical understanding of the customer base. New metrics will be needed to identify sources of strength, areas of vulnerability and high-value priorities. Adapting to the new framework will require tighter coordination among business units as well, with the product and treasury groups agreeing on the value of balances that potentially can be acquired and delivery channels upholding the analytically-guided targeting framework.
Running in Place
In the new environment of digitally-enabled rate shopping and disruptive competition, Canadian institutions have increasingly turned to limited-duration promotions to compete for consumer deposits.
In the beginning this seemed like a good idea. From the isolated perspective of an individual bank, a limited duration high-rate promise has a two-fold potential benefit. Not only can a successful rate promotion attract new customers and fresh balances, but it also can provide longer-term opportunities for relationship expansion. Indeed, the first banks to use such promotions saw some success, inspiring others to follow.
But the collective result, not surprisingly, has been a lot of running in place. After the first movers left the gate, other banks became fast followers, determined to match or exceed the disrupters in market-leading promotional rates. Promotional effectiveness rapidly decayed, with falling response rates and rising runoff of acquired balances.
If all banks increase their promotional rates — and the industry seems to be heading quickly in this direction — no institution sees meaningful incremental balance growth. But all see increased deposit costs in the long run. Particularly with overlapping geographical footprints and national-level pricing, the market has quickly reached an unsustainable point — a “race to the bottom” with ever-increasing promotional frequency and rising rate premiums (Figure 1: Crisis in Promotional Deposit Pricing).
What led us here so quickly? The core driver is changing consumer behaviour in a digitizing marketplace for banking and financial services:
Shopping. Banks traditionally advanced their deposit promotions “offline,” via local advertising, branch staff and collateral, and in response to phone calls from the occasional diehard shopper. With distribution and rate information bounded by the local activities of a few major players present in most markets, most banks adopted a national strategy on deposit pricing. Rate offers could be consistent, largely irrespective of geography or client circumstance.
The embrace of digital by banks and consumers alike has radically changed information access. With the proliferation of online ads and deposit offers, consumers need not look up at billboards, read local papers or even step into a branch. The availability and aggregation of online rate information makes rate comparison shopping easier and more transparent. In turn, more consumers are becoming active and informed shoppers.
In a recent Novantas survey of Canadian consumers, roughly 40% of respondents said they prefer to use digital channels to research savings accounts and guaranteed investment certificates (GICs). The top search destination is individual bank websites, followed by independent sites where banking-related information is available. Social media is also continuing to emerge as a consumer influence (Figure 2: Digital Research and Shopping for Non-Chequing Deposit Products).
Origination/switching. In the pre-digital world, consumers had to invest significant effort to shop for a higher-yielding account and switch deposit balances, providing a natural barrier to deposit churn. Deposit shoppers had to monitor their current deposit rates and GIC expiry, research local rates, venture out to a competing bank to open an account, and wait for the funds to clear. Rate differentials between institutions seldom were large enough to offset the consumer opportunity cost of managing deposit rates more closely.
But digital deposits have reduced these switching costs, easing the friction that limited deposit movement and account churn. Consumers are becoming more willing to open new savings accounts online — and to venture beyond traditional banking companies. The new competitive universe includes digital and direct banks, non-bank mortgage lenders, and other innovative institutions and FinTechs that show up in web search engines and aggressive ad campaigns.
Among respondents to the Novantas survey, roughly 45% cited digital channels as the preferred way to open new savings accounts and GICs. Within this category, the majority of respondents said they conducted their online shopping via desktop or laptop computers, with others using tablets and smartphones.
Surveyed consumers also expressed much higher preferences for digital purchase, though far exceeding actual digital account opening volume today. This is not a sudden tilt, but more of a relatively rapid evolution. Directionally, strong consumer feedback on digital purchase preference does underscore a changing market. Indeed, non-traditional institutions are making a bigger splash these days. And the major banks feel the pressure to respond to these promotional rate offers.
The upshot with digital shopping, aggressive promotional offers and the increasing cascade of responses is that broad deposit promotional campaigns are increasingly prone to upward rate pressure and unintended consequences. Online information and aggressive offers are sensitizing consumers to rates, making it harder to stand out in the crowd. Among Novantas survey participants who said they had skipped their primary bank and gone elsewhere to open a savings account or GIC, for example, the top swing factor was “attractive rates,” cited by nearly 40% of respondents.
Customer rate sensitivity has an impact even when customers stay with their banks. Our research shows a growing potential that promotions will catch too much attention within the established customer base, encouraging accountholders to transfer balances to capture higher rates on new offers. In such circumstances, the cost to carry increases for the provider and meanwhile there is no balance growth.
How Bad is it? The Measurement Imperative
To understand the magnitude of the issue at hand and identify potential solutions, a core task is to develop the right measures of promotional cost and effectiveness. A warning and avoidance system is needed to help the bank steer away from ill-fated promotions with diminishing returns. Two key measures are deposit balance retention and the true marginal cost of promotional deposits:
Balance retention. Banks have always expected some runoff after a promotional period ends and rates move lower, especially from “hot money” depositors. But balance runoff can be excessive for certain customer segments, negating portfolio growth even as the bank churns through a series of different offerings.
Understanding deposit decay patterns among existing accountholders, and not just with new money, is now even more important. Customer segmentation by deposit retention rates provides clear direction on which segments the bank should value most, and what offers to make to preserve and grow stable deposit balances. Measuring “stickiness” versus “runoff” has profound implications on which deposits have long-term value and are worth the promotional effort.
In fact, leading institutions globally are starting to incorporate these measures of deposit retention into their liquidity valuations, and even advancing their funds transfer pricing capabilities to differentially account for the lower liquidity value of “hot money” and higher valuations for more stable relationship deposits.
Marginal cost of promotion and cannibalization. Savvy institutions must monitor the effects of promotion “cannibalization,” occurring when current accountholders see their bank offer higher promotional rates in the general marketplace and transfer balances internally to take advantage.
All too frequently, campaigns invisibly sink underwater when this dynamic is omitted from deposit planning. The true marginal cost of promotional deposit balances takes into account: likely new deposit runoff, an estimate of cannibalization of existing balances at higher rates, and the overall long-term retention of promotional deposits.
Internationally, our research shows that the unwanted repricing of current balances is increasing at a rapid rate. The only way that banks can recognize their individual exposure is via in-depth analysis of promotional and core balances — not a snapshot, but rather a granular time series analysis that digs down to the customer level.
Charting a Course
Canadian financial institutions share a common challenge of meeting higher growth needs for core deposit funding in an increasingly digital marketplace. This is a concern not only for the executives responsible for deposit gathering, but also bank treasury units.
- On the regulatory front, the Basel III liquidity requirements — in particular, the anticipated impact of the new Net Stable Funding Ratio (NSFR) — are ratcheting up the pressure for core deposit funding and constraining the ability of banks to continue using short term unsecured borrowing to fund their lending activity.
- Wholesale funding is becoming costlier, reflecting energy sector’s strains on credit quality, and rating agency actions earlier this year.
- Housing prices and household debt have spiked in recent years; a real estate bubble burst and/or worsening consumer credit would heighten liquidity needs.
In this unfolding scenario, each institution needs to map out its emerging needs for core deposit funding and realistically assess the role and influence of promotions — both offensively and defensively. Does the institution understand the extent of its exposure to promotional fatigue? This knowledge then shapes the deposit agenda (Figure 3: Setting the Agenda for Promotional Pricing).
- For the bank with high growth needs but low exposure to promotional fatigue, the agenda is to pair traditional promotional practices with a test-and-learn program for new product structures and offerings — and do so before fatigue sets in. Banks with this fortunate profile still have headroom to use standard promotions, but not indefinitely. They need to build analytic muscle so that new approaches can be proactively deployed as needed, not as emergency responses. Options include targeted use of rate offers to segments with better potential for balance retention, and product innovation to capture rate-sensitive customers with a differentiated proposition.
- For the high-needs/high-fatigue bank, the agenda is daunting. There may be little choice but to maintain traditional promotional practices in the near term, albeit with diminishing returns. Yet banks in this category have the greatest opportunity for payback by testing their way into more advanced pricing approaches. Specifically, the customer learnings gleaned from current promotions provide a wealth of data to segment customers by their cost and retention characteristics.
- For the low-needs/low-fatigue bank, the historical agenda can continue for now, with sparse use of traditional promotions — measuring balance runoff and the marginal cost of funds to ensure portfolio health.
For the low-needs/high-fatigue bank, the agenda is to “get off the treadmill” of endless promotions with declining results. Moving to a value exchange logic (e.g., an “everyday good price” rate while the customer is in core cash management) while excluding segments or geographies from promotions can improve the cost/runoff equation with minimal detriment to the deposit growth trajectory.
So what are the common themes across these agendas?
First, financial institutions will need to invest in the analytics and technology needed to capture the effectiveness of traditional promotions and develop and deploy more advanced approaches. This will require more granular customer data, including transaction-level history and shopping behaviour, to better target pricing (this data also allows for segment-level pricing for those with the capability). Applying analytics to deeper data will equip the bank to assess strategies on a real-time basis, allowing the institution to dip into and out of promotional approaches by market and customer segment when circumstances warrant.
Second, capabilities need to be aligned with promotional philosophy. Some institutions believe in “segment-of-one” targeting, using specific price points that are not broadcast to the broader customer base. Others worry about customer and front-line acceptance of these differentials and instead opt for transparent, give-for-get logic — providing rate incentives tied to the acquisition and retention of core balances.
Third, the organization will need to evolve its rhythms on how the product and marketing teams interact with the front-line in the preparation, delivery and measurement of campaigns. Old measures around aggregate uptake rates and balance inflows need to be upgraded to measures of promotional impact, net of cannibalization-adjusted marginal costs and balance runoff. Marketing must become more nimble to deliver more targeted offers, more frequently. The front line will need the right proof points to deliver the new reality with conviction.
Fourth, whatever the tactical agenda, analytic development should be supported by an aggressive test-and-learn program for new field applications — leveraging technology and omni-channel offer delivery to maximize returns on these efforts. For many institutions, progressing beyond traditional promotions will allow them to maintain structurally lower deposit costs while achieving required funding levels.
Finally, there is an issue to consider at the treasury and bank level — especially if actions such as those above are not sufficient. That is whether to question the traditional asset/funding growth logic, which focused more on setting loan growth targets and then tasking the deposit units with funding the expansion. Increasing promotional deposit fatigue may well call into question whether shareholder value is better maximized with analytically-derived deposit growth serving as a governor on asset growth, especially in a high consumer loan-to-deposit ratio environment, rather than the other way around.
Adel Mamhikoff is a Managing Director in the Toronto office of Novantas Inc. Hank Israel is a Director and Andrew Frisbie is a Managing Director in the New York office. Also contributing were Chris Musto, Director, and Adam Stockton, Principal, both in the New York office. The authors can be reached at firstname.lastname@example.org, email@example.com, firstname.lastname@example.org, email@example.com, and firstname.lastname@example.org, respectively.