Retail banks around the world are grappling with rising interest rates, slowing economic growth, and market conditions that will pressure margins in the months ahead. How should banks approach deposit cost management to protect growth and profitability?
Interest rates are rising fast and furious as central banks in developed markets scramble to slow historic levels of inflation.
The US Federal Reserve has lifted interest rates from near zero at the start of the year to between 3.00 percent and 3.25 percent in September. US Fed Funds rate is forecasted to rise above 4.5 percent in 2023. This will be one of the fastest paces of rate hikes in decades. Central banks in Switzerland and UK, and the European Central Bank (ECB) have all raised rates since January to counter runaway inflation. In the case of the ECB, a 50-basis point (bps) interest rate increase in July 2022 represented the Eurozone's first rate hike in more than a decade and the end of an eight-year regime of negative interest rates for 19 European nations. In September the ECB hiked rates again by 75 bps. More ECB rate hikes are expected.
In addition to the evolving macro-economic environment, banks are also grappling with more intense competition, elevated digital expectations from customers, and digital-only challengers willing to offer higher yields for savings and deposits.
Deposit cost management will be particularly challenging in the months ahead.
Missteps in pricing could trigger a price war. Switching banks have never been easier, faster or better. However, banks who rely solely on higher rates and blanket marketing campaigns will struggle to control costs and put additional pressure on margins. Central Banks' shrinking balance sheet could also drive negative deposit growth particularly in commercial segments.
How should banks approach deposit portfolio management and pricing in the new rising rate environment without compromising profitability and growth?
Do you have a differentiated approach to deposit product design and pricing?
Taking a differentiated approach to design deposit offerings means banks can meet portfolio volume goals at lower costs. Most depositors are price insensitive and have an inertia bias which means they will stick with existing interest-free products and are unlikely to transfer funds, either internally or externally to the institution. However, some customers are price sensitive where small changes in price impacts their decisions and value perception. For these more attentive customers, banks can find ways to stay competitive as rates rise, and design attractive deposit offers to retain them.
Using a cloud-based deposit optimization engine, banks can output anywhere from five to 5,000 price points for their portfolio of deposit products to optimize for customer segments and market conditions across regions. Using this approach one large North American bank was able to realize more than 45 million dollars in deposit cost savings while keeping deposit portfolio volumes unchanged.
Supported by elasticity data, banks can design and differentiate deposit products to appeal to customer segments. This can help control deposits costs, prevent attrition and grow deposits in a more sustainable way.
Banks can derive customers’ deposit price elasticity by monitoring the movement of funds internally and externally to accounts held outside the bank. Banks can also conduct statistical analysis including A/B testing to refine pricing to optimize deposit cost management.
Are you able to accurately anticipate customer behaviours?
Another key element to effective deposit portfolio management is the ability to accurately predict customer behaviours in response to a change in a deposit product's interest rate and bound term, which locks access to the fund for a period.
In a recent study of Swiss bank customers, Simon-Kucher found changing a savings product's bound term from one-year to two-years without an even greater increase in interest rates, raised the chance of customer churn substantially. Similarly, the study revealed a critical inflection point where increasing deposit yields from 50 bps to 75 bps greatly improved the chance of winning over customers from competing banks with lower offers.
While interest rate has the greatest relative importance in the decision-making process of the Swiss consumer, and type of bank offering the savings product also played a relatively important role in the customer's decisioning, according to the Simon-Kucher study.
Banks must remain vigilant to monitor the marketplace closely. A challenger bank looking to gain market share might decide to make a bold 'move-the-market' manoeuvre and hike interest rates to a level where it is offering 25 bps or more above comparable offers in the market. A move like that could potentially increase a bank's deposit portfolio by 40 percent of more.
Are you able to get the right offer to the right customers at the right time?
Leveraging flow-of-fund data modeling where a bank tracks fund movements internally within the institution and externally, banks can also acquire a more comprehensive understanding of their customers' banking behaviors including switching and loyalty behaviors.
By observing flow-of-fund movements, banks can also identify critical junctures-of-conversion where strategically placed offers have high probability of turning a casual customer into a primary banking relationship. For example, a large Canadian bank noticed that bank customers who have been with the bank for a year or less are more likely to move funds out of the bank when a deposit instrument’s term ends. Armed with this insight, this bank orchestrated a multiproduct bundle offer with lucrative rewards, including a complimentary video streaming subscription, to retain and convince these customers to consolidate their financial accounts with the bank.
Are you deploying retention efforts with precision?
This is also the time to fine-tune retention strategies. Banks who are not practicing customer-relationship optimization to identify and retain their most valuable customers must begin to do so. Central banks are pursuing aggressive strategies to fight inflation, and interest rates are going up at a record pace. The last thing any bank wants is to find itself having to re-acquire valuable deposit-relationships later in the cycle when rates are higher.
An analysis of fund movements can reveal patterns and enhance a bank's ability to identify customers at risk of attrition and to deploy the appropriate retention strategy. Close analysis of banking behaviours can also uncover opportunities for product innovation. One European bank used pricing differentiation to reward and drive bank loyalty, where customers with multiproduct holdings and a deeper relationship at the bank could enjoy more competitive rates.
As new technologies become increasingly available, banks are no longer limited to single product lines of knowledge, data, and expertise housed in silos. Instead, banks can move towards building a more comprehensive understanding of their clients in order to orchestrate personalized retention programs, product offers, pricing and communications.
We are entering a rising rate environment that will test and challenge traditional deposit management efforts. Banks will have to act with greater precision, speed and ingenuity to protect margins and growth.
The ECB's Interest Rate Hike and What It Means for the Pricing of Customer Investments: https://www.simon-kucher.com/en/blog/ecbs-interest-rate-hike-what-it-means-pricing-customer-investments
Watch a video: Simon-Kucher's Dynamica| Deposits is a comprehensive approach to leverage pre-existing data to optimize deposit portfolio pricing, visualize forecasts, compare stats against competitors, and more