To nurture core deposit relationships in a tightening market, winning banks will leverage the customer information advantage for more targeted deposit pricing and marketing.
As retail banking executives prepare for the next cycle of rising interest rates, many are asking themselves what it will take to win. Competitors now value core deposits more highly because of regulation, and meanwhile depositors are likely to seek advantaged rates — particularly established customers who have been stuck with low-yielding accounts for years and have a pent-up hunger for attractive alternatives.
In the advent of a true market jump, many banks will be handicapped in their deposit pricing responses. Broad-brush pricing still is prevalent in the consumer deposit business. And even though fairly uniform pricing represents the bank’s best estimation of internal need for funding and general market requirements, it often collides with the realities of a diverse customer base.
The opportunity for growing deposits at an advantaged rate in an increasingly competitive environment lies in surgically targeting pools of attractive deposits. That implies segmenting the customer base and offering each segment what it wants (access, functionality, etc.), at prices the bank can afford to pay.
The demand for rates varies widely across a typical bank’s customer base, calling for tailored responses. Some customers primarily look for convenience and service, and price is not a primary factor in their banking decisions. Other customers constantly shop for the best return and will chase a better offer at a moment’s notice. To the extent these “hot” balances are needed, targeted rate offers should be fenced to prevent cannibalization. In the middle are customers who view rates as just one part of the value proposition and do not constantly shop. Often these are valuable relationships, deserving a balance of good rates and good functionality.
An ability to distinguish between these groups will be critical in managing the deposit portfolio going forward. Segment insights can be used to identify and nurture sticky balances, or alternatively to tap the most rate-sensitive customers for short-term funding needs. This requires one set of strategies for steadily building cost-effective long-term balances, and another set for attracting rate-sensitive balances “as needed” through the selective use of aggressive pricing.
Much depends on the skillful use of one of banking’s great underutilized assets — information on customer product usage. The majority of new balances come from current customers, providing an advantage for banks that can derive relationship insights from the rich account and transaction data that is available internally. Success, however, will require a stronger analytics infrastructure and an ability to target customers in their preferred channels for shopping and transactions.
Keeping Up With the Market
Traditionally banks have used a priori segmentation schemes that consider factors such as product type; balance tier and term; and pricing variations seen in local markets within the branch network footprint. They heavily relied on the branch sales force to cross-sell products to established customers, augmenting marketing with direct mail campaigns to high-potential prospects. More granular customer-level strategies were minimal.
With the ongoing customer migration away from the branch to alternative channels, banks have suffered a blow to the traditional deposit marketing and sales model. Yet they have gained a potentially powerful new ability in direct marketing. No longer limited to paper- and counter-based interaction, institutions can conduct segment-targeted campaigns that reflect relationship dynamics and reach customers electronically.
The catch is that at many banks, deposit pricing capabilities have not kept up with changes in the market. To be sure, there have been meaningful advances, both in analytics that identify variations in customer price elasticity, and with the systems used to deploy more granular pricing schemes for use in the field. Yet for the vast majority of deposits, most banks still use a fairly traditional rate grid to set prices.
A key emphasis (especially prior to the recession) has been pricing for balance acquisition. To selectively attract deposits while minimizing the distribution of aggressive offers where they are not needed, banks have honed their skills with introductory promotional rates, off-term specials for certificates of deposit, and protections embedded in the terms and conditions that go with promotional accounts. All of these tactics are product promotional approaches to growing deposits, and they completely ignore segment- and customer-level behaviors once the balances have been acquired.
Thus the more customer-centric issue is how to optimize pricing across the different needs and expected behaviors of established customers. Over the last five years, the depressed rate environment lowered expectations, and many customers essentially ignored the rate on their deposit accounts. When rates rise, there will likely be a leap in account turnover and balance migration as people search for higher returns.
Banks need to be prepared to refine pricing according to what the customers want and what the bank can afford, and also to recognize and nurture non-price drivers of customer loyalty. Higher rates may be well-justified for some customers; in other cases rates will not be on the customer radar screen. It will be critical to be able to tell the difference and determine when and how to pull various levers in marketing and pricing.
The Case for Advanced Modeling
To win in the new environment, banks will need to match an improved understanding of customer needs and attitudes with an ability to execute pricing strategies surgically. The pricing team must be able to make segment-informed tradeoffs in attracting long-term balances versus short-term funding.
Advanced deposit modeling will be a critical capability in many of these decisions. By analyzing customer profiles and behaviors, including individual transaction details, banks will find justification for using rates in many varied ways.
Primary checking account customers have favorable behaviors that speak to the value of targeted campaigns. Novantas analysis shows that customers with an active checking account are less demanding about rates, plus they are more likely to retain balances regardless of promotional campaigns. The top priority for such customers is building strong payments and cash management franchises to retain their convenience-oriented savings balances (Figure 1: Three Fundamentals of Deposit Growth Strategy).
Additionally, established customers typically supply more than half of the balances garnered in mass market promotional campaigns. On average these balances are twice as likely to remain with the bank beyond the first year, compared with new-to-bank customers. Skillful banks can use targeted pricing to attract an even greater share of long-term balances from the current customer base by finding “situationally elastic” customers who will respond to a premium offer and then keep the money with the bank. These balances are more valuable from both an economic and a regulatory standpoint.
Most banks are just beginning to learn how to place these constructive core customer behaviors into a framework for targeted deposit marketing and pricing, leaving the retail banking industry in a general state of strong dependency on mass-marketed campaigns. It is time for a course correction.
In the future, targeted campaigns to build long-term balances should take priority, and aggressive mass-marketed pricing to attract hot money should be reserved for use only when needed to fill gaps in short-term funding. In situations where aggressive campaigns prove necessary, they should be conducted in controlled circumstances (e.g., tough restrictions, select markets) to minimize potential cannibalization.
Although current market and portfolio dynamics remain quite manageable overall, the calm can be deceiving. Typically in a rising rate environment, a point is reached where many longstanding deposit customers become sensitive to account yields and begin to consider the possibilities of getting a better deal. Rate shopping can go from a trickle to a flood, leaving unprepared banks at risk of losing valuable core deposits.
To prepare for this eventuality, banks will need new levels of expertise in relationship pricing. Rich internal data on core customers will provide a valuable start, turning the question to segment-targeted analytic models, pricing strategies and marketing campaigns. Will competitors be ready in time?
Rich Solomon is a Managing Director and Adam Stockton is a Principal at Novantas Inc., a management consultancy based in New York City. They can be reached at firstname.lastname@example.org and email@example.com, respectively.