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Deposit Pricing Strategies in a Rising Rate Environment

Retail Banking, Price Optimization | Jan 19, 2022
Deposit Pricing Strategies in a Rising Rate Environment

Current market forecasts suggest that we will soon see Fed funds, and subsequently, retail and commercial deposit rates, rise in 2022. Banks are anxious to see an expansionary rate regime to push open net interest margins and thus, signal the improving demand for loans. Tepid loan demand and rock-bottom margin spreads have been an anchor on bank earnings over the past year and we are collectively anxious to return to a more traditional rate curve.

Inflation has been prevalent across news and media headlines lately, and for good reason. Supply chains remain somewhat disrupted due to Covid-19 adaptations, the demand for goods is rising, and there is excess liquidity in the money supply. Together, these three forces are lifting prices higher. On the one hand, recent growth in core consumer prices, commodities, equity values, and real estate prices give concern that the market is exuberant. On the other hand, unemployment remains fluid. The current trajectory of the economy could be an indication that we are getting “back on track.

When Will Deposit Rates Rise Again?
In one way or another, we all have experienced the effects of an ample money supply and shortages, as well as an increased demand for goods. In its effort to tame inflation at full employment, the Fed is expected to implement a first rate hike of 25-50bps as early as April. In the later parts of 2022, we should see an additional three rate hikes which means the Fed rate is likely to increase by 100-150bps by year’s end.

How Can Banks React to Rapidly Rising Rates?
Different banks will have varying strategies to react to rising rates depending on their current loan-to-deposit ratios, FTP rates and rate movements of their relevant competitors. While determining the ideal Beta is a tactical decision, all banks should be considering the below strategic factors to prepare themselves for the rising rate environment.

  • Rising Rate Regime Models
  • Forecasting models typically rely on historical data to identify trends and sensitivity in the portfolio to predict future balance flows. The last two years have been a flat-rate environment with a strong customer preference for liquid products due to market volatility. Models that are trained using this data can produce inaccurate and irrelevant results and should be avoided when using predictive analytics to make rate decisions in a rising rate environment. Robust models that offer rate environment and COVID impact input levers, are better suited to capture the price elasticity and emerging trends of previous rate environments. Enhancing the model accuracy is essential to gaining a competitive advantage when building out pricing strategies.
  • Relationship Pricing
  • Customer-level segmentation attributes including, direct deposits, bill pays, tenure, lending relationship and engagement with digital channels, will help identity loyal customers who are also typically less price-sensitive. Incentivizing customers through onboarding programs and personalized offers and pricing, will drive increased customer primacy and lower price sensitivity in the deposit portfolio. This approach allows the ability to lag or offer a lower Beta as Fed rates rise to maintain a higher NIM and protect balances from attrition.
  • Mining Transactional Data
  • Transactional data can be leveraged to add more granularity to the flow-of-funds analysis and to better differentiate between price-driven and recurring outflows. The outflow of money from a competitor rate change is a vastly different transaction compared to recurring mortgage payments. Built-in capabilities that can identify the difference should be incorporated into deposit modeling improving the prediction of rate-driven balance movements in a rising rate environment

We are poised to enter a rapidly increasing rate environment and it’s clear that waiting for NIM expansion will not improve your bank’s performance today. Dive deeper into this topic by accessing the complete white paper titled: Deposit Pricing Strategies in a Rising Rate Environment.