The U.S. banking industry has always followed a very simple formula: Intermediation 101 calls for banks to gather deposits from local depositors (primarily retail) and lend to local borrowers (primarily businesses). But over the past few years, Novantas has been warning that this formula is fundamentally at risk. Deposit-gathering has become a national business that is dominated by a few national banks and direct banks. The most recent set of earnings reports shows this clearly — banks are experiencing challenged deposit growth and there are warning signs that deposit betas are rising. Novantas believes this phenomenon and the associated funding challenge are secular, not cyclical, trends.
SOLVE THE RETAIL DEPOSIT FUNDING CHALLENGE…OR FIND A BUYER
This issue isn’t only a retail-banking matter, but a concern for the very top of the house — from the executive floor to the boardroom. Retail deposits will be the primary limiter of growth, while commercial DDA and sleepy wealth deposits, will dry up.
Banks are starting to address the issue by considering the right side of the balance sheet, looking at how fast they can grow stable, low-cost deposits and assessing lending capacity. This marks a change from the traditional way that banks tackled strategic planning by considering the left side of the balance sheet to determine how fast a bank can profitably and prudently grow lending, and how those loans should be funded.
As of now, too many institutions still haven’t laid out a comprehensive plan to adjust to the demise of the local retail-banking model that has dominated this country for the last hundred years (see Figure 1). But the evolution of deposit-gathering, occurring against a backdrop of rising rates, means banks must consider a wide range of choices. That means thinking about a thin-branch network, launching a direct bank or pursuing partnerships to extend geographic and/or product reach. In May, Citizens Financial became one of the latest banks to pursue a new strategy when it announced plans to launch a national direct-to-consumer digital platform that will offer deposit accounts.
The stakes are high. Novantas believes that funding pressures will increasingly drive M&A activity as the scale advantages on the deposit side will drive many community and regional banks to combine because their required betas to drive deposit growth have become untenable. Indeed, a slew of banks have recently announced merger plans.
One possible outcome is the creation of several more ‘mega-banks’ (if regulators allow it) that can compete better with marketing and technology scale. Banks that don’t solve their deposit funding challenges will have no choice but to sell out.
RETAIL DEPOSIT STRATEGIC PLAYS
Banks need to sort out which one (or combination) of retail strategic plays will address their funding needs.
The first option to be considered is to double down on the local franchise and take share from competitors. To do this, banks need a distinctive value proposition (“Why bank with us?”); very few banks have one today. The days of getting ‘fair share’ based on convenient local branches are in the past as more consumers pursue digital formats. That means banks must move from distribution-led strategies to customer-level ones by developing a value proposition, distinctive products, and additional marketing spend.
But for many regional banks, there simply isn’t enough opportunity in the current footprint. Banks that find themselves in this position should consider one of several types of out-of-footprint plays.
National banks like Bank of America and Chase have pursued well-documented approaches to “attach” new markets (Minneapolis for Bank of America and Jacksonville, Fla. for Chase) to their existing footprint with thin-market plays that involve limited physical footprint, ‘feet on the street’ marketing, and new digital products.
Another option is to take a local segment play national. Because banking is becoming an extremely national business, winning players may take a segment proposition that is distinctive in footprint, and take it to other markets. These can be true in retail or commercial segments, as banks like USAA, First Republic and Silicon Valley Bank have demonstrated.
And of course there is the national direct bank option that has been pursued by MUFG Union Bank with its PurePoint brand, among others. While the up-front investment marketing costs and interest rate may be high, it still may be cheaper than the high ‘marginal cost of funds’ of pricing up in footprint balances and ‘polluting’ the back book. A related strategy is a national affinity play in which the banks teams up with another brand to provide white-label deposits — as Webster has done in the HSA business.
Needless to say, the right play (or combination of plays) will vary for each bank based on footprint, value proposition and capabilities, and funding needs.
DEVELOPING A SUSTAINABLE FUNDING STRATEGY
While in the heat of the deposit pressure, banks may be tempted to be reactive and only use tactical levers such as price and marketing campaigns to drive short-term growth. But these levers may well run out of steam or become inordinately expensive as rates rise. Given this, it is critical for banks to develop a proactive longer-term deposit growth strategy, assessing a range of strategic options such as the ones laid out above, to determine a viable path for generating adequate deposit growth at acceptable cost of funds.
To support the development of the strategy, new tools are needed. Banks need scenario-based planning of different potential macro-economic and funding environments to stress test their strategies. Will the proposed strategies work if betas are higher than expected, or five more direct banks enter the fray? They also need analysis to evaluate funding across the enterprise under different scenarios. And they need ongoing enterprise-wide and retail deposit funding and price optimization tools that incorporate sophisticated ‘marginal cost of deposits’ (mCOF) measurement to understand the true marginal cost of different plays, including the costs of ‘polluting’ the back book. These tools will allow banks to course-correct to determine where to get the next $5B of deposits.
Banks that figure this out will be able to continue to grow and survive in the new environment. Banks that don’t will need to combine with others and may become part of the next set of super-regionals or even mega-banks.
EVP, San Francisco