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2nd Quarter 2023: Deposit Mobilization - A Race to the Bottom of Margins

NEWSLETTER| Wed Apr 12 2023

In this environment where retail deposits are more valuable and more expensive, the competition for deposits continues to heat up. Banks with liquidity challenges turn to promotional pricing to raise rate-sensitive deposits – a race to the bottom of margins. As banks compete for rate-based deposits, they expose themselves to significant repricing risk. Promotional rates not only risk repricing the existing book of business, but also repricing BAU acquisition of deposits which would naturally have joined the bank at existing rates. This represents significant incremental interest expense, particularly for banks with strong core checking and convenience-oriented savings and demand deposit growth.

Without accurate measurements and reliable projections, banks are unlikely to avoid these pitfalls. While large banks continue to gain market share, small to mid-sized and emerging banks cannot afford to misallocate scarce resources. Maximizing efficiency of both interest and marketing expense is critical. These banks thus trade-off rate-based pricing costs against other potential growth investments. In addition to an all-in acquisition cost, including dollars of rate paid and incremental marketing costs, banks must also budget for repricing and cannibalization of the existing book at lower-cost savings, as well as attrition after the promotion expires.

A detailed understanding of the overall marginal cost of funds and the levers that impact it, along with a comparison to benchmarks, allows banks to diagnose potential issues. In the absence of this expertise, bottom line erosion will accelerate.

Considering the current volatile rates scenario, the betas for the marginal cost of funds may exceed promotional betas where the beta on the marginal cost of funds is likely to significantly exceed 100%, rendering banks that have historically relied on promotional tactics, vulnerable to excessive margin compression as rates increase.

BBA’s benchmark research demonstrates balance churn increases by 50% in a rising rate environment compared to a low-rate environment, impacting both cannibalization and decay. Cannibalization rates will increase as more customers attune to rate-based offers. Decay rates will also increase as customers become less tolerant of lower base rates after promotions expire. The cost of cannibalization and opportunity cost of acquisition will severely challenge promotional pricing.

Targeted pricing to specifically seek balances from customers with low potential repricing impact and behaviours can help address the imbalances created by promotional deposits. Consistency across the Treasury, BU and organizational buy-in is crucial to identify and correct tradeoffs and avoid underperformance.

In addition to embedding the marginal cost of funds logic into strategic planning and resource allocation processes, banks need to socialize a standard calculation for marginal cost of funds in concert with Treasury and Finance. This multipronged collaboration enables the business and Treasury to look beyond average spreads to the incremental impact of specific pricing decisions and strategically maximize margins and profitability.