Banks face a real quandary as they consider what to do about their deposit portfolios. As asset yields have collapsed, banks have responded with steady reductions in deposit yields, which have fallen by more than 300 basis points since 2007.
But even with yields at historic lows, more tightening will be needed given the market outlook for the next few years. At a macro-economic level, it now appears that interest rates will stay low well into 2015, if not longer. Meanwhile asset yields are continuing to fall (11 basis points during the first quarter of this year alone), with the implication that margins will stay under profound pressure for some time to come.
The good news is that there is a significant excess supply of deposits in the marketplace — at roughly 70%, the current industry loan-to-deposit ratio is at its lowest point in 25 years. In fact, Novantas estimates that there is more than $1 trillion of excess deposits relative to loans in the system, which gives banks additional flexibility to optimize deposit pricing. In an industry with close to $9 trillion in deposits, each basis point in savings is worth nearly a billion dollars in net interest income.
As banks look to lower deposit yields further, protecting quality customer relationships takes clear priority over the quantity of standalone, low-profit deposits. This means condensing the portfolio around the best core depositors (those with a primary checking account) who remain loyal even in today‘s era of extremely low interest rates. Basel III puts some regulatory teeth into this as well by assigning lower liquidity coverage requirements for consumer relationship accounts.
But it is not a simple matter of across-the board rate reductions for non-relationship customers (as attrition will be brutal) or mass-marketed promotional rates tied to relationship checking (which may disappoint in terms of the ability to cement primary relationships). Instead, more targeted and nuanced approaches are needed.
There are two priorities in the quest to increase levels of quality deposits. The first is cross-selling additional “sticky balances” to core customers, further extending and cementing these valuable relationships. The second is optimizing the trade-off between attrition reduction and margin preservation with established accounts.
While banks have made great strides in pricing sophistication, few have successfully reached the level of segment-based responsiveness. There is a clear rationale for developing this capability going into 2013, given the compelling need for artful engagement with select groups of core deposit customers in special circumstances (Figure 1, “The Segment Factor in Deposit Pricing and Cross-Sell”).
The first step is to identify and capitalize on opportunities to capture “off-us” (i.e. external) balances held by relationship customers. The second is to efficiently price relationship balances after they are brought to the bank.
Cross-sell — As banks consider how to condense deposit portfolios around quality core relationships, one of the strongest possibilities is to win even more “sticky balances” from relationship customers, who typically have two dollars of “off-us” balances for every one dollar held at their primary bank. The best customers to target are “situationally elastic,” or easily motivated by rate-based offers to bring additional funds to the bank, yet unlikely to chase yields elsewhere after promotional rates expire.
While cross-selling is a decades-old priority for retail banks, the dynamic of this critical effort has changed considerably. Back when branches were king and bankers frequently got the chance to interact directly with customers, sales success hinged on personal interaction. Now, however, targeted marketing is coming to the forefront as people skip branches in favor of popular alternatives such as online and mobile banking.
Underscoring the profundity of this shift, Novantas research shows that roughly a fourth of retail banking customers are now “virtually domiciled,” meaning that they seldom, if ever, return to branches after opening initial accounts. An additional 50% of retail customers make significant use of non-branch channels.
This trend appears destined to continue and actually accelerate, which while disrupting the traditional face-to-face branch sales model, opens a new world of possibilities to drive targeted direct offers through the Internet, the phone, and even automated teller machines. In turn, banks are increasingly using advanced analytics to identify pockets of relationship customers who likely will respond to specific rates.
Compared with the aggressive Web-only banks, retail banks have a significant competitive advantage in targeted rate competition in that they are able to draw on the rich information stream generated by in-depth customers, including patterns with automated clearinghouse (ACH) transactions and debit and credit cards. For example, one leading bank identified a set of ACH transaction patterns that not only signaled the presence of “off-us” balances, but also propensity to respond to a rate-based offer and propensity to stay at the bank after the promotion expires. These markers were used to identify a distinct group of customers who then were targeted with special offers.
Further propelling the trend toward targeted direct marketing of deposits is the general atmosphere of fatigue around mass-market promotions. Banks do not need high-volume growth right now and broad rate-based offers carry the risk of “adverse selection” by attracting too many yield-chasers who remain poised to leave the bank as soon as a better offer comes along.
Portfolio Optimization — Beyond cross-sell, a second priority is to improve the handling of portfolio pricing for established accounts. The goal is to make efficient use of rates to ensure the retention of more price-sensitive core customers while de-emphasizing price with less sensitive segments.
One example is the use of segment-level offers with renewal promotions on certificates of deposit. While the least price-sensitive accounts will renew into standard products, more sensitive accounts are targeted with either liquid offers (i.e. money market or savings accounts) or promotional CDs.
Leading banks use similar tactics to manage liquid accounts after introductory rates expire. By analyzing likely price elasticity at a customer segment level, the bank can identify the proper pricing levels required to retain balances at a granular level. A number of leading banks identify segments that will receive automatic exception pricing, or that will be offered an alternative product at a more competitive price point. These strategies are critical in maximizing profitability on the existing portfolio.
Beyond the Fundamentals
As retail banks strive for stronger engagement with core deposit customers, it is important to not only master the fundamentals, but also to flesh out a full system for segment-based deployment, including sales and performance measurement. To take advantage of these opportunities, the table stakes include an ability to identify variations at a segment level, as well as an ability to deliver granular pricing:
Segment-level elasticity — To identify quality balances, banks must calculate the price/balance relationship on both balance formation and retention at the segment level. This analysis can be overlaid on current segmentation schemes, or it can be used as a factor in developing new segmentation frameworks that draw on other customer metrics beyond what the bank traditionally uses to set rates.
Delivery system — The new analytics will be useless if the rates cannot be implemented at this more granular level. Banks will need flexible systems that enable them to vary rates within a single type of product on both new and current balances. Additionally, progressive banks will gain new flexibility in designing customized bundled products that can be targeted to select customer segments.
While these components will be essential in the quest for quality over quantity in deposit formation, future market leaders will invest in several additional areas:
Segment-level funds transfer pricing (FTP) — Simple product-level FTP approaches do not incent banks to target quality over quantity in the short term. To properly incent growth of the most valuable type of balances, the key is to assess differential account value at a segment level and use the findings to provide internal guidance to the business lines.
For example, “relationship customers” typically have much longer account tenure and far less price sensitivity, and they should be assigned higher funding rates for pricing decisions in the field. Such refined FTP guidance is critical, for example, in enabling banks to pay up to attract segments of CD customers who will likely renew multiple times at more reasonable standard rates. Several leading banks have incorporated segment-level insights into their FTP systems.
Performance tracking — Banks must be able to actively track performance at a granular segment level, not only to spot trends and develop test-and-learn capabilities, but also to make sure that segment-level strategies are being properly implemented in the field. Among other applications, the most advanced banks are calibrating FTP rates at a segment level to properly incent the business lines.
Multi-channel sales — Particularly in the call center and online, routines will be needed to quickly identify and proffer the appropriate segment-specific rates, as segment-level pricing is most effective through direct channels.
Shifting the Mix
Facing an extended era of slow growth and razor-thin margins, banks must make a concerted effort to shift the mix of their deposit portfolios, with the quality of account relationships taking precedence over the quantity of balances, particularly from peripheral customers who largely base their loyalty on rates. Along with financial necessity, such efforts will be propelled by regulatory pressure as well.
While non-price factors largely drive core customer loyalty — things like convenience, recognition, and service — a meaningful number of core depositors still are price-sensitive in special circumstances, such as when considering cross-sell offers or deciding whether to roll over a maturing CD.
Segment-targeted pricing will be especially valuable in such circumstances. But while new levels of analytical expertise will be required, there is far more to the journey. With the branch increasingly relegated to a component of the multi-channel customer experience, there is an urgent need to rebuild the sales outreach so that relevant and timely offers find their way to target customer segments via their preferred channels.
For banks that can match segment-targeted pricing with distribution innovation, there are distinct opportunities for deposit portfolio improvement in 2013, setting the stage for multi-year competitive advantages as well.
Sherief Meleis and Rich Solomon are Partners in the New York office of Novantas LLC, a management consultancy.