As the Federal Reserve aggressively hikes interest rates to tamp down inflation, depositors are starting to demand more for their money.
Results from IntraFi’s most recent quarterly survey of bank executives indicate the trend is likely to continue. Ninety-five percent of respondents expect funding costs to go up, and 71% said deposit competition will increase. But this doesn’t mean banks have to let macroeconomic forces or competitors dictate their strategies.
Matt Pieniazek, president and CEO of Darling Consulting Group, recently joined me on Banking with Interest to discuss how banks should think about their balance sheets in the current interest rate environment. He explains why all institutions need clearly documented game plans, how to extricate rate from the value proposition, why rising rates are a good thing, and much more.
What follows is our conversation, edited for length and clarity:
What are you seeing right now vis-a-vis banks and bank balance sheets?
The delta between market rates and what banks pay has never gotten this wide this fast. Even if depositors aren’t looking to move their money, it’s hard for them to ignore what’s happening.
Additionally, during the pandemic, we made it easier to do things electronically and conditioned customers to avoid branches. Today, banking practices are very different than they were three or four years ago. So the dynamics are about to get really interesting, notwithstanding the excess liquidity still out there.
What’s your advice to banks?
Have a clearly documented game plan. (Many banks don’t.) Start by figuring out how much money you can, or are willing to, let leave; then determine which deposits are most valuable and prioritize those.
Next, divide your deposit base into manageable pieces. Start by rank-ordering your largest-balance relationships (this will help with one-off conversations). Second, review your mass-market, traditional banking relationships. Third, review the “tweeners,” or those that aren’t quite whales but larger discretionary balances that could be at risk (mid-tier balances commingled with operating balances in those traditional accounts).
Get your people in a room to assess the elasticity of deposits in each sector and your value proposition for those different consumer types, specifically, whether it’s driven by rate or other factors. Figure out your pricing strategy for each and how much outflow you’re willing to accept in each area and why.
How is social media adding to deposit pressures?
It’s definitely having an effect, but banks need to remember that there’s always somebody paying more than them. If rate were the most important variable, every other bank would go out of business, and you’d have one big bank paying the highest rates. The point I’m making is that if banks fuel conversations about rate to where it becomes the main topic of discussion, they’re communicating that their value proposition is mainly tied to rate instead of the other things they bring to the table.
Conversely, depository institutions that believe in their value propositions will do well during this cycle because they’ll know where they can be proactive. They’ll experiment more, try more things.
. . . during the pandemic, we made it easier to do things electronically and conditioned customers to avoid branches. Today, banking practices are very different than they were three or four years ago.
What are your thoughts on strategies for banks that aren’t dealing with excess liquidity?
I’ll start by saying there are many banks with concentrations of large balances that don’t want pricing on these to upset the apple cart. They don’t want a handful of accounts messing up their core deposit strategies, so they’ve been paying higher rates than usual. Then, they’ve been going and selling the money into a deposit network, such as IntraFi’s, through its One-Way Sell program. This enables them to effectively lower their deposit costs and keep the money out of their deposit expenses by moving it off the balance sheet, knowing they can bring it back on
if necessary.
Coming back to your question, banks borrowing money are actually pushing local market pricing up. They don’t match wholesale, but they’ve got a long runway, given the delta between market rates and what other banks are paying. They’ll pay a lot more than other institutions, but they’ll also save a lot. Right now, borrowing banks are facing high opportunity costs, so if they’re dealing with a larger account, they’re more apt to pay up or negotiate. Otherwise, they’ll just have to replace them with something substantially more expensive.
We’ve seen a lot of disruption in the past two years from COVID and other factors. How should banks be thinking about ALCOs right now?
Way too many ALCOs tend to be more of a reporting function that spends too much time creating detailed decks that do little more than give people headaches. Then, toward the end of meetings, they’ll shoehorn in conversations on what to do. Those institutions have it backward. ALCO should feed strategy. It should be a profit center, not the cost center it tends to be.
What are the biggest mistakes banks are making today?
One is that they’re not changing loan pricing to levels that represent fair, risk-adjusted returns. They’re letting the liquidity overhang get in the way. The majority of banks – not all – are knowingly doing deals at perhaps the tightest spreads ever. But their business models don’t support FHLB plus 150 to 200. They don’t support SOFR plus 150 to 175. They don’t support prime minus 100 or more. Banks have to get away from all that. They can’t let irrational and desperate competition dictate their ongoing lending strategies. They need to improve their balancing act.
Another is that many banks don’t socialize the logic underpinning their value propositions. They don’t explain how to deflect objections to those who work on the front lines. They don’t institute formal feedback loops, either. Banks should never underestimate the importance of communication, coaching, and guidance.
