Pay now or pay later? – The American banking industry’s next move

After the bailouts of Silicon Valley Bank and Signature Bank, deposits have once again become front and center. Instead of repeating what went wrong or speculating on the next shoe to drop, banks should use this opportunity to look ahead and prepare now for what is likely to happen over the next two to three years.

It’s no secret that 15+ years of near-zero interest rates have distorted banking. With little value in deposits, banks were driven to focus on isolated products that generated fees or profits rather than focusing on customers’ holistic financial needs. Fintechs and digital upstarts emerged to fill the gaps, but lacked a true balance.

What the current interest rate cycle shows is this: When you offer an item without anything else around it, you invite your deposits to run to the highest bidder. And after being dormant for 15 years, bank customers are now waking up to the fact that they can earn higher returns on their money.

History can be a good teacher here. What the banks gain from the interest rate increase can easily be given away in the long term.

The chart above outlines the last sustained rising interest rate cycle we had back in 2004. During the first two years of this cycle, banks printed money while capturing the spread between the Fed Funds rate and deposit costs. Eventually, however, customers woke up and moved their deposits, and the banks paid dearly to get them back over the next 4 years.

Remember, this was pre-iPhone – which wasn’t introduced until 2007. Today, customers can move millions of dollars, 24×7 from anywhere in the world. Bank runs today can happen with a tweet and the touch of a finger.

Once consumers make these initial deposit shifts, it can take years and huge amounts of money to bring those deposits back in. And the great transparency of the prices on Bankrate.com and other comparison sites increases the challenge. As a result, banks will have to offer increasingly much more than the Fed Funds rate to regain their share.

So the banks have a choice: pay now or pay later.

Pay later is an easy choice right now; it is to let someone else worry about bringing in deposits back to the bank at a later date. Pay now is where we think the real opportunity is.

Put the focus back on integrated product innovation

The best way for regional and medium-sized banks to combat this is through integrated product innovation. Banks should focus on wrapping a suite of products – mortgages, credit cards, car loans, etc. – around their deposit customers and reward them for the total value of all the products they use, similar to the experience they get from Amazon Prime.

Some banks have already excelled in doing this. I mentioned Bank of America earlier as a gold star example, having achieved close to a 99% customer retention rate by wrapping their products around the customer with an integrated loyalty program that recognizes the total value of their deposit and credit products.

The hardest thing for many banks to do now is take a hit to their P&L, but it can be worth it. Many of these innovations will add costs in the short term to provide more reward and value to the customer. But providing more value now can save you from having to give up over the next five years. The short-term challenge may outweigh the future pain.

These offers help improve customer stickiness while lowering the deposit beta that banks have to pass on. It also helps banks understand their customers on a deeper level and provides an incentive to bring more business to the bank.

The banks have a window of opportunity to prepare for the other end of the yield curve. The good news is that product innovation is well within the reach of any regional bank in North America, but the clock is ticking. The time has now come to think old fashioned and get back to the basics of banking.

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