Today, you can’t read a single article about the US banking industry without finding some reference to rising rates and its impact on bank earnings. It is a given that deposits are going to get more expensive as the Federal Reserve continues to raise rates. This, in turn, may also lead to slower loan growth, which likely will result in lower bank margins over the mid-to-long term.
On the deposits front, the US banking industry deploys a number of pricing structures from product and tier to regional, promotional and relationship packages. Interestingly, select banks have started testing differentiated rates via email, but this is still a niche practice.
Central to these pricing structures (product, tier, region, promotions, package) is a “one-size-fits-all” approach, making the promotion rate available to all customers within the combination. Banks have largely priced deposits for demand – if there is a need for liquidity, dial up the rate; in the event of excess liquidity, dial down the rate. Deposit pricing practices are still product, P&L and balance sheet centric, as opposed to customer centric.
But this begs the question, “In today’s world of advanced analytics, machine-learning, artificial intelligence, cloud computing and big data – shouldn’t we expect more personalization of deposit rates?” Different customers have different needs, and deliver differentiated liquidity to the bank. So why then are all customers getting the same rates?
For customer-centric deposit pricing, it is helpful to look at three factors:
- Customer Need: Customers seek savings and CD products for different reasons– saving for a vacation, down-payment towards a home purchase, steady-state transfer to build a rainy day fund, a child’s college fund or a place to park some money till an attractive investment opportunity presents itself.
- Customer’s Deposit Duration: Customers also bring different types of liquidity to the bank. The vacation saver expects to use the savings in the near term – perhaps within the next 12 months. The child’s college saver is looking to access the funds many years later, bringing much longer tenured liquidity.
- Customer’s Deposit Amount: In addition to the duration deposits are expected to stay with the bank, the amount of deposits also significantly impact the liquidity delivered by the customer. The saver waiting for an investment might bring large-sized liquidity but with very short duration, while the college saver might be making small deposits over a longer period of time.
None of the aforementioned factors and dynamics are captured within a product, tier or region construct for interest rates. Understanding a customer’s need and setting more customer-centric deposit rates allows banks to deliver an exceptional customer experience, better quantify the life of the deposits on the balance sheet, and better clarity on the liquidity profile of the bank. Moreover, such a strategy can significantly help the P&L. Considering a customer’s liquidity profile (needs, duration & size) and providing pricing at a customer level allows banks to effectively manage interest expenses and portfolio betas.
The ability to manage pricing at a customer-centric level is also extremely effective in volatile rate environments. In a rising rate environment, banks can differentially pass on central bank rate increases to establish customer relationships. For example, customers building their first savings and seeing proactive rate increases may lead to stronger brand loyalty, while the rate increases would cost the bank relatively low in interest expenses for this customer. In a declining rate environment, banks might want to accelerate rate cuts on different customer profiles. Consider this, deeper rate cuts for savings deposits awaiting investment are better rationalized compared to the same deep rate cuts for customers saving for a child’s college.
A personalized deposit pricing strategy works best when customer-centric pricing principles are extended to other parts of the retail bank to benefit both retail customers and their banks. Pricing and underwriting of loans and mortgages can be more effective using the learnings of the customer from the deposit side, as well as implementing customer-centric pricing strategies on loan products. For example, the customer saving for a home can be provided with a mortgage rate benefit if deposit goals are achieved at the time of account opening. Achieving the deposit goals that result in the mortgage rate benefit is a great motivation tool, provides exceptional customer experience, enables the bank to better underwrite the customer and enhance the P&L.
In closing, there are significant benefits to both the customer and the bank with customer-centric pricing. The analytics and technology capabilities are readily available to identify and execute customer-centric rates. The only question is, which banks are going to lead the way in challenging the status quo of existing pricing practices?
