Regulators are paying more attention to deposit rates, highlighting the importance for banks to conduct a deep analysis of their portfolios so they can justify their pricing strategies.
The heightened scrutiny by regulators, which has been reported by the media and confirmed to Novantas by a number of bank executives, comes at a time when managing deposits is already far more complicated than it was a year ago. Rates paid for balance acquisition have hit an inflection point in retail and commercial deposits, pushing marginal betas higher. Institutions are being challenged by new direct-bank entrants, a shift among wealth customers out of deposits and into non-deposit alternatives and a product-mix shift to CDs.
The latest issue is tied to an FDIC rule, known as FIL-25-2009, that was approved in May 2009 when interest rates were close to zero. The rule, which was enacted in 2010, sets caps at 75 basis points above a set of national rate averages from all FDIC-insured institutions and branches.
Many bankers want to see the rule updated, arguing that the nearly decade-old methodology is unreasonable in the current rate environment. Although the cap technically only applies to banks that are considered to be less than well-capitalized, bankers have said the caps are increasingly becoming an issue in exams.
The FDIC assesses compliance with the rule by comparing rates that are offered by an institution with a set of FDIC-imposed caps that vary by major product type, balance tier and maturity for time deposits.
As a result, banks must be ready to demonstrate the details of their rate positions to regulators.
RATE CAPS AND LIQUIDITY RISK
The regulators’ concern about liquidity risk that may result from “hot money” deposits are not unfounded. Novantas Comparative Deposit Analytics (CDA) data consistently shows an inverse relationship between rate paid relative to market and the structural liquidity life of balances. It is particularly the case for deposit products with promotional/teaser rate periods or, more generally, when the competitiveness of a bank’s pricing position deteriorates over time.
As rates continue to increase and banks use price more dynamically as a growth lever, customers will have meaningful alternatives. Banks must manage the associated liquidity risks.
Many bankers feel these rate caps are overly conservative, given current competitive pricing dynamics. CDA data show that acquisition rates have exceeded caps in recent months, suggesting that banks in strict compliance with the caps will struggle to meet planned deposit growth unless they have some other type of compelling value proposition that isn’t tied to price. As of September 2018, the median rate on balances from new-to-bank savings accounts was 160 bp, a healthy 71 bp above the FDIC rate cap of 89 bp. Moreover, CDA data show that upwards of 80% of acquired balances were originated with rates above the 89 bp rate cap, up from 45% two years earlier.
ASSESSING RATE BY SEGMENTS
Institutions will be most successful if they can report on both acquisition rate and portfolio rate trends on a granular basis. Product type, balance tier, and maturity are table stakes, due to the structure of the FDIC caps, but bankers may find a more nuanced narrative by segmenting market/region and customer type — especially given the wide variation for rates along these dimensions. Market/region is essential for larger institutions that span multiple geographies due to the inherent variation in competition and demographics.
Banks can also segment by customer type, which is conspicuously absent from the regulatory caps. This will help to illustrate supply-side and demand-side differences across consumer, small business, wealth, commercial/corporate, and public funds customers. For commercial/corporate and public funds customers, the incidence and level of exception pricing should be considered because standard rates become less representative of actual rates each time the Fed moves.
Banks can furthermore defend their rates by monitoring customized competitor groups, which themselves could vary by product, market/region and customer type. Banks often use third-party promotional rate data that provide information on stated/posted rates. CDA trends suggest material differences between these advertised rates and actual acquisition rates that are captured through, account-level interest expense data. The appropriate due diligence around the current rate positions, both internally and relative to the industry, can tell a different story than a simple, aggregated comparison to the regulatory interest rate caps.
BETTER ANALYTICS CAN HELP TELL THE RATE STORY
In addition to explaining the current rate position, it is more important than ever to strengthen analytic capabilities and use the outputs to explain and develop a forward-looking strategy.
Elasticity, which is the relationship between relative rate position and deposit balance flows for acquisitions, switching and retention, is a common capability that supports rate management. Bankers should use insights from elasticity modeling to identify, at the most granular level, the deposit segments that should be priced more or less aggressively relative to market rates. This can help to optimize balance growth more cost effectively.
It is also critical to capture liquidity behaviors for the internal valuation of deposits through funds transfer pricing. Assumptions that are calibrated in a compressed interest-rate environment where large pools of cash are left idle, however, are quickly becoming obsolete. Treasurers should ensure structural liquidity (or long-term stability) factors into the relative competitiveness of acquisition pricing. An influx of rate-seeking, non-relationship customers potentially merits an adjustment to the liquidity buffer. Leading institutions recognize these challenges and are using forward-looking models to more accurately value high-priced deposits and set incentives accordingly.
Elasticity and liquidity measurement are two critical inputs to an enterprise deposit strategy that should be weighed not only along growth and cost axes, but also with an appreciation of liquidity value. Effective strategies consider tactics at the enterprise level (across individual lines of business) with an eye toward cross-business optimization. Bankers should evaluate in a forward-looking way along both near- and longer-term time horizons and across a range of scenarios that consider market interest rate and competitive pricing variables.
Discipline and effectiveness of rate management will, in large part, determine the winners and losers in this current rate cycle. It is conceivable that caps could be recalibrated, but until that happens, banks may well have to price above caps in order to meet planned growth, exposing the bank to unwanted regulatory scrutiny. Proactive planning and investment can help to limit the speed bumps.
Director, New York
Managing Director, New York
EVP, New York