Pay Now Or Pay Later? – The U.S. Banking Industry’s Next Move

Following the bailout of Silicon Valley Bank and Signature Bank, deposits have become front and center once again. Instead of rehashing what went wrong or speculating on the next shoe to drop, banks should use this opportunity to look ahead and prepare now for what’s likely to happen in the next two to three years.

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

What the current rate cycle is proving is this: When you offer a commodity with nothing else around it, you are inviting 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 could be earning a higher return on their money.

History can be a good teacher here. What banks gain in the rate rise, can easily be given away in the long run.

The chart above outlines the last sustained rising rate cycle we had back in 2004. During the first two years of that cycle, banks printed money as they captured the upside spread between the Fed funds rate and the cost of deposits. Eventually, though, customers woke up and moved their deposits and banks paid dearly to get them back for the next 4 years.

Keep in mind that 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 touch of a finger.

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

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

Pay later is an easy choice right now; it’s letting someone else worry about bringing deposits back into 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 midsize banks to combat this is through integrated product innovation. Banks should focus on wrapping a series of products – mortgages, credit cards, auto loans, etc. – around their deposit customers and rewarding them for the total value of all the products they use, similar to the experience they receive from Amazon Prime.

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

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

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

Banks have a window of opportunity to prepare for the other end of the interest rate 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 is now to think old school and get back to the basics of banking.