This is a post about ways you can better manage deposit betas.
In this post we'll cover:
- some of the history behind deposit betas;
- ideas on how to manage deposit betas;
- common questions asked about deposit betas;
- and strategies on how to resolve these questions.
Let’s get started.
Rock & Roll, Deposit Betas, and Some History
I remember the hit song in 1981 “Under Pressure” (released by Queen and David Bowie) and often think of it when I consider the competitive banking climate we are now in.
Today, as bankers, you are constantly under pressure with your depositors and rates. All bankers throughout the country are constantly fine-tuning and focusing on how important their institution’s deposit rates impact net interest margin and the bottom line. In Asset Liability Committee (ALCO) terms, the words “deposit beta” are often used to describe the change in funding costs divided by the change in interest rates. Rising deposit betas may require some community banks to change their focus on customers, products, and ALM assumptions or risk a reduction in profitability.
Before 2019 the general feeling was that deposit betas were much lower when compared to previous rate cycles. Those feelings were, in large part, confirmed as banks calculated deposit rates ranging less than 20 percent on their deposit rates versus historic cycles usually ranging from 30–45 percent.
Many industry experts have studied why deposit betas have been toned down versus past cycles. Some reasons include the massive amount of bank reserves versus historical levels, increased regulation, higher non-interest cost, and management’s desire to maintain margins levels consistent with what they’ve experienced over the last two decades. In recent years, customers seem to be paying more attention, since the competitive rates are now above inflation rates, implying a uptick in real earning. Throwing in funding needs growth and changing customer demand competition gives you a good formula for higher deposit betas.
The review and analysis of deposit rates and their projected betas is never a one-and-done or one-size-fits-all approach. Variables such as geography and market competition heavily weigh on the sensitivity of these rates. New York and the Southeast region tend to have the highest deposit betas while areas in the Midwest have the lowest. In more competitive markets, we’re beginning to see certain products being tied to short-term interest rates. Tying your non-maturity deposit rates to short-term rates, you remove flexibility to manage these rates, which can be challenging in a rising rate environment. Another factor is institution size; community banks have been slower than regional and big banks but will likely have to play catch-up if they lagged over recent years.
A trend we’re now experiencing is banks spending more time improving and incentivizing the deposit operations department. While it’s long been the standard to establish programs like this in lending, these departments at the bank are vital to providing low-cost funding, which can then be deployed in earning assets such as loans or securities. ALCOs are rolling out new customer loyalty programs and improving customer relationship training with office administrators and controllers at their commercial accounts.
Additional Ideas to Manage Deposit Betas
- Tier certain deposit products and manage their rate changes separately, creating some low beta products (most often with lower balance tiers).
- Focus on certain demographics that exhibit low deposit beta behavior.
- Increase duration of client relationships through training/education/incentives.
- Use cross-selling strategies and customer loyalty programs.
Questions and Strategy
If your bank experienced higher betas earlier in a cycle, how much will it take for competition to catch up? If your bank is smaller than market competition, will it lose market share? If loan demand is picking up, how long can the bank support these growth levels with these higher funding costs?
As you and your bank strategize and consider these questions, remember there are many reasons, other than interest rate, why customers choose to deposit their funds at a given bank. Studies have determined that consumers place higher value on characteristics like convenience, service, availability, and technology than on deposit rate pricing. Also, keep in mind that assumptions, by definition, have limitations, since they can vary from what actually occurs in reality. Smart risk managers should always use worst-case scenarios to stress test assumptions regularly. If your bank hasn’t been considering implementing these concepts, it might want to do so. Successful exam visits from the regulators can result from your taking time to revisit these interest rate risk concepts, making adjustments to your ALM model, and stress testing.
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About the Author: With a BS degree in Finance, an MBA, and over 33 years of experience in the financial and banking industries (30 years with FPS GOLD), Matt truly understands and lives the culture of our business and your commercial banking industry. mattd@fpsgold.com