Banks need to clarify their deposit needs over the next few years and overhaul the metrics, skills and strategies used to drive deposit gathering.
For years, savvy banks looking for deposit growth have met both long-term funding goals and short-term “surge” requirements through well-deployed approaches to promotional deposit pricing. With firmer economic recovery now bringing higher loan demand and rising rates, the number of banks needing higher deposit growth is set to expand.
But there are clear signs that promotional pricing is losing its luster — if one properly measures response rates, cannibalization and overall cost — signaling a need for comprehensive metrics and enhanced campaign approaches, and, for some, soul-searching about the cost of mandated growth goals.
This change is a sharp turn from prior deposit-gathering dynamics. Not so long ago, web-based rate information was far less prevalent, and progressive players could use tight geographic fencing to capture pricing advantages in varying local markets. Information friction also made it easier to advertise for new balances without touching off repricing waves among current customers. And with fewer regulatory mandates demanding an emphasis on retail deposits, competition was less intense as many players took advantage of alternative funding options.
Currently, market forces are fundamentally changing the structural advantages of core deposit gathering. Increasingly accustomed to web-enabled shopping, consumers can effortlessly monitor rate trends and offers on a national basis. And as interest rates continue to rise, consumers will regain a significant incentive to shop for better deposit account rates.
Taken together, the situation has introduced a heightened risk of diminishing returns or “promotional fatigue.” Campaigns that initially had strong success in prior years are progressively losing energy. In a vicious cycle, the bank is left in a position of needing to launch more promotions, yet each campaign is less effective than the one that came before (Figure 1: Crisis in Promotional Deposit Pricing).
To chart a more sustainable course, banks need to clarify their deposit needs over the next few years and overhaul the metrics, skills and strategies used to drive deposit gathering. In particular, two key measures matter: 1) balance “persistence” over time, and 2) the full marginal cost of promotions counting cannibalization of lower-cost deposits. Finally, they will need to exercise new organizational muscles, as moving away from the old promotional standby can require new coordination between organizational units.
Such efforts will be required to maintain stable deposit costs amid heightened regulatory emphasis on core deposit funding. First movers also stand to gain fresh competitive differentiation, given that basic market analytics for deposit pricing are now in widespread use.
Then and Now
As executives prepare for deposit competition over the next rate cycle, they need to step back and consider how the levers of deposit promotion have changed — in particular, the ability to limit promotional offers by geography and only for new deposit funds (Figure 2: Changing Influences).
Proliferating information; changing reference rates. In the past, banks advanced their deposit promotions through local media advertising, branch collateral, and phone calls from the occasional diehard shopper. These “offline” processes basically kept deposit markets fairly local, limiting reference rates to nearby alternatives and allowing multi-market banks to tailor price based on local deposit demand.
The Internet has radically changed information access. Online ads bring deposit offers to consumers who need not look up at billboards, read local papers or step into a branch — prompting them to consider shopping. The availability and aggregation of online rate information makes rate comparison shopping easier and more transparent. And consumers are becoming more willing to open new savings accounts online, including with non-local providers, playing into the hands of direct banks that show up in web search engines touting “the best rate” nationally.
Lower switching costs — Deposit shopping and balance movement previously required significant consumer effort, providing a natural barrier to deposit churn. Pre-digital banking, deposit shoppers had to monitor their current deposit rates and CD expiry, research local rates, venture out to a competing bank to open an account, and wait for the funds to clear. Rate differentials between local banks had to be large enough to offset the opportunity cost of managing deposit rates more closely (even larger to cross geographic markets). But digital deposits have reduced these switching costs, eliminating the friction that limited deposit movement and account churn:
- Aggregation sites provide easy, anonymous, anywhere access to national rates.
- Online fulfillment makes account opening immediate and convenient.
- “Me2Me” transfers allow electronic 1-3 day money movement, enabling consumers to open and keep savings accounts separate from payment accounts.
- Online account management provides instant information for consumers to monitor balances and rates, and to optimize across accounts and banks.
- Combined, these factors have made it much easier for depositors to optimize rates on their balances, opening the door for many more customers to move their money when profitable opportunities present themselves.
Regulatory influences. Previously, retail deposits were one of many acceptable sources in a diverse funding mix. Banks had greater freedom to tap commercial and brokered sources, in many cases permitting loan growth well beyond what could be supported by consumer and small business deposits alone. While sticky core deposits remained a preference, there were few regulatory constraints associated with the use of liquidity alternatives.
Now, however, the regulators have inspired banks to increase the internal valuation of core deposit funding over other deposits. With the implementation of Basel III, consumer and small business deposits are treated more favorably in calculating the liquidity coverage ratio, increasing their value compared with most alternatives. This regulatory change now encourages existing retail players and new entrants to compete more aggressively for retail deposits — including the use of promotional rates.
Variations in analytic acumen. During the prior rising rate environment in 2004-06, only the largest banks could leverage analytic sophistication to improve promotional effectiveness. Their less sophisticated competitors were relegated to “one price for all,” leaving them less nimble in moving in and out of the retail funding marketplace.
Today the use of enhanced deposit analytics is the competitive norm, increasing the likelihood that tailored promotions will be more widely used and therefore less responsive. Sophistication in systems, targeting and pricing analytics is now seen among smaller multi-market regional and community banks, and the direct banks are piling on as well. New layers of analytics will be needed to stand out in the marketplace.
Begin with the Right Measures: Persistence and Marginal Cost
Simply abandoning promotional pricing is not an option for most banks — and those with high growth requirements may need to be particularly active. And as rates rise, even a bank with modest growth requirements will require replenishment of the deposit book, given natural churn and the rising attrition expected as more customers become active rate shoppers.
Given the situation, a core task is developing the right measures of promotional cost and effectiveness — a warning and avoidance system that will help the bank to steer away from ill-fated promotions with diminishing returns. This includes undertaking sophisticated longitudinal analyses to learn how existing customer segments and balances evolve over time and respond to promotions. Two key measures are deposit “persistence” and the true marginal cost of promotional deposits.
Balance persistence. 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 balance growth even as the bank churns through a series of different offerings.
Understanding deposit decay patterns among existing customers, and not just with new money, is now even more important. Customer segmentation by deposit persistence patterns provides clear direction on which customer segments the bank should value most, and what offers to make to preserve and grow stable deposit balances. Measuring persistence has profound implications on which deposits have long-term value and are worth the promotional effort.
Marginal cost of promotion and cannibalization. Savvy banks must monitor the effects of promotion “cannibalization” — occurring when existing depositors see and take up higher promotional rates for current deposit balances. 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 persistence of promotional deposits.
The big picture — made clear by a granular, customer-level analysis over time of promotional and existing balances — is that the unwanted repricing of current balances is increasing at a rapid clip.
Charting a Course
Each bank needs to understand the extent of its exposure to promotional fatigue. This knowledge, combined with the growth outlook, then shapes the deposit agenda — which will depend on the funding growth needs of the individual bank, and the promotional challenges facing the bank in each of its markets and products (Figure 3: Setting the Agenda for Promotional Deposit Pricing).
- For the low-growth/low-fatigue bank, the historical agenda can continue for now, with sparing use of traditional promotions — measuring balance persistence and the marginal cost of funds to ensure portfolio health.
- For the low-growth/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 meaningfully improve the cost/persistence equation with minimal detriment to the deposit growth trajectory.
- For the high-growth/low-fatigue bank, the agenda is to pair traditional promotional practices with a test-and-learn program for new product structures and offerings — and to do so early before fatigue sets in. Banks with this fortunate profile still have headroom to use standard promotions in many markets, but it will not last through this upcoming rising rate cycle. These banks need to build analytic muscle so that new approaches can be proactively deployed as needed, not as emergency responses.
- For the high-growth/high-fatigue bank, the agenda is daunting. There may be little choice but to maintain traditional promotional practices in the near term, flawed though they may be. Yet banks in this category have the greatest opportunity for payback by testing their way into more advanced pricing approaches on a region-by-region basis.
So what are the common themes across these agendas?
First, banks will need to invest in the analytics and technology to capture the effectiveness of traditional promotions and deploy more advanced approaches to improve them. In a dynamic environment, customer expectations and competitor responses will continue to intensify, which will require more granular customer data, including transaction-level history and shopping behavior, 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 bank to dip into and out of promotional approaches by market when circumstances warrant.
Second, capabilities need to be aligned with promotional philosophy. Some institutions believe in “customer-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 persistent retention of core cash management 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 after considering marginal costs and balance persistence. 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.
Finally, whatever the tactical agenda, analytic development should be supported by an aggressive test-and-learn program for new field applications — leveraging technology and multichannel offer delivery to maximize returns on these efforts.
For many banks, moving beyond a simple adherence to traditional promotions will allow them to maintain structurally lower deposit costs while achieving required funding levels. For others, such measures may not be sufficient — calling into question whether shareholder value is better maximized with analytically-derived deposit growth serving as a governor on asset growth, rather than the other way around.
Hank Israel is a Director and Andrew Frisbie is a Managing Director in the New York office of Novantas Inc. They can be reached at firstname.lastname@example.org and email@example.com, respectively.