Banking used to be simple. Invest in core capabilities like branches, ATMs and cash management platforms. Gather stable, inexpensive deposits. Lend the money at a tidy net interest margin. Add fee revenue. Rinse and repeat.
The financial crisis changed that formula. Rising deposit levels and weak loan growth have caused a tidal wave of liquidity. At the same time, falling interest rates and rising fees have depressed margins on these growing liquidity portfolios to near zero. And the impact of Dodd-Frank Act, Basel III and other regulatory changes will further reduce the profitability of deposit relationships.
Little wonder some bankers now ask: "Do we even want deposits?"
The answer is "yes," with an important caveat: banks must be more discerning in gathering deposits.
Leveraging a deeper understanding of customer behavior, banks can build a more profitable, stable deposit base, while structuring more efficient cash portfolios that rest on this strengthened funding capacity.
There are three actions banks can take right now to build a more profitable deposit business:
1. Get a better handle on deposit duration. Since the financial crisis, bank treasurers have, understandably, chosen to err on the safe side when investing deposits. Applying generic and overly pessimistic assumptions of how long customers will keep their money in an account, banks have kept durations short and avoided less liquid, higher-yielding instruments. But with liquidity at record levels, a lot of money remains on the table for banks that don't get these assumptions right.
Enhanced analytics built on more precise segmentation and account-level flows can provide a more refined view. For example, by more accurately measuring the true core cash component of deposit accounts for specific customer segments and markets, banks typically find that a large portion of their customers are unlikely to permit their deposit balances to fall below a minimum core level required for managing their cash.
2. Be smarter about pricing. Interest cost reductions of even a few basis points can greatly increase spread revenue in the current rate environment. When negotiating deposit rates with key customers, banks rightly show flexibility and a focus on overall relationship profitability. However, sales officers and pricing desks frequently misjudge the rate sensitivity of these customers and overpay.
Institutions that use advanced elasticity-based pricing models uncover differences in rate sensitivity and competitive conditions across customer segments, markets, product-usage profiles and balance levels.
Capturing these elasticity differences through differentiated product offerings and negotiated pricing guidelines will enable the bank to eke out additional spread right now, while positioning for even larger margin gains once rates rise.
3. Seek out stable deposits. Not all deposits are created equal. Understanding customer rate sensitivity and deposit stickiness, banks can tailor focused product and sales strategies.
For example, a careful assessment of the small business segment may reveal that non-core customers are highly rate sensitive and require a promotional rate to reel them in, but can develop a more attractive profile when cross-sold certain value-added products. On the commercial side, resourceful banks have discovered niche market segments with highly stable depositors, and then designed product, pricing, and sales strategies to win in these markets.
Making all of this happen requires investment in tools and staff. Additionally, more effectively linking deposit gathering and balance sheet management requires breaking down the silos separating the treasury function at a bank from the lines of business. Finally, more centralized, but flexible, governance processes are critical to improving pricing capabilities.
None of that is simple. But taking a more rigorous approach to managing the deposit portfolio will capture significant value in a difficult banking environment.
Shyam Venkat is a Principal in PricewaterhouseCooper’s financial services advisory practice in New York. Stephen Baird is a director in the practice in Chicago.