While consumer and residential lending woes dominate the headlines, the retail banking industry has an equally serious issue to think about: the unprecedented challenges facing the slumping deposit business.
Although healthy balance growth in savings and money market deposit accounts can be expected as nervous consumers go "short and liquid" with their funds, the profit picture is adverse.
Banks are caught in a vise. The dramatic Fed rate cuts have whetted customer expectations for lower interest rates on loans. However, pressing liquidity needs and rising online competition have hampered banks' ability to lower rates on deposits.
The resulting squeeze likely will cause most banks to miss their growth targets on deposit spread income by more than 5% this year. For the industry as a whole, this suggests an annual revenue gap of more than $30 billion — hard to make up elsewhere.
The situation requires a more nuanced deposit pricing strategy that enables the bank to capitalize on pockets of opportunity in the overall market. While there's no single lever that can be pulled to improve deposit profitability, there are many possibilities for focused pricing initiatives, and together they can make a significant difference.
Leading banks are taking a three-part approach to the deposit challenge: refining goals and pricing strategies for each major type of product; tailoring regional initiatives to reflect key differences in local markets; and responding to salient variations among customer segments.
Products. The first task is to look ahead and assess the market's likely impact on various types of deposit products, and then set strategies consistent with the bank's goals.
In this year's recessionary atmosphere, for example, many customers will place renewed emphasis on safe, short-term instruments. In turn, banks generally can expect balance growth of 5% to 10% in money market deposit accounts and savings accounts. Conversely, balances held in certificates of deposit likely will contract.
Precision pricing strategies will be needed to capture the flood of money coming into liquid savings while limiting the erosion of CD balances. And these increasingly rely on expertise with price elasticity of demand, or statistical measures of the extent to which customers adjust deposit balances in response to rate changes.
With CDs, for example, the goal is to set rates just high enough to attract customer balances without overpaying.
With savings, by contrast, a two-part pricing strategy is needed. One part entails selective aggressive offers to attract "new money," including teaser rates, new products, and "hip-pocket" specials to be used in individual customer negotiations. The other part focuses on maximizing the profitability of current accounts without provoking attrition.
Markets. Our research repeatedly highlights dramatic differences in deposit pricing among various geographic regions. For example, a recent Novantas analysis of rate data from Market Rates Insight showed a variation of more than 150 basis points in average money market deposit account rates among the 50 states.
Such skews extend to major metropolitan areas and all the way down to "micro-markets," or local areas where target customers live, work, and shop. Seldom, however, does a bank vary its local rates to the extent seen in the markets it serves. Instead of adapting, bankers fuss about rate competition, accusing rivals of "irrational pricing."
Actually, our research indicates that retail banking competitors each choose their overall rate structures quite deliberately, with competitive disparities reflecting sharply differing funding needs and strategies.
Among top-20 banks competing on similar money market deposit account products, for example, Novantas has found differences in funds transfer pricing rates (internal bank measures of the value of funds) of up to 85 basis points, a fortune in today's rate environment.
So rather than adopting a defeatist attitude about rate competition, retail banks should elevate their reconnaissance, and learn to pick their branch network battles dispassionately. In some areas it is worthwhile to compete vigorously for deposits, for example, while in other areas aggressive promotional rates are unwarranted.
Customers. Customer-level pricing has been used for decades in other industries and financial services sectors outside of retail banking. Passengers on a typical airline flight, for example, may have booked their tickets at 20 to 30 different price points.
Increasingly, retail banks are considering areas where individually tailored deposit pricing makes sense. The all-important activity of CD renewals, for example, can be improved with elasticity-based pricing concepts and customer-level price targeting.
Clearly, additional capabilities will be needed to take full advantage of these concepts. While retail banks have come a long way, there's a race in pricing-related areas such as staff analytic talent, market and customer analytics, tracking and measurement of balance flows, and information technology.
Despite current difficulties, the retail deposit business remains the crown jewel of the banking industry, by our estimates accounting for more than $500 billion of shareholder value, or 40% of the industry total. As such, efforts to elevate pricing strategies are amply warranted. Winning deposit strategies will not only recognize but capitalize on differences in products, markets, and customers.
