Curinos (F)insights

Episode 01: The Implications of Higher Interest Rates

July 13, 2022 Rutger van Faassen Season 1 Episode 1
Curinos (F)insights
Episode 01: The Implications of Higher Interest Rates
Show Notes Transcript

This month, Rutger van Faassen sits down with Adam Stockton to discuss higher interest rates.

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Rutger van Faassen: Hello, and welcome to Curinos (F)insights, the podcast that explores some of the most pressing topics for financial services, insights that help you navigate today and anticipate tomorrow.

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Rutger: Hello, and welcome to the Curinos (F)insights podcast. Today, my guest is Adam Stockton, who is Head of Retail Deposits Benchmarking & Strategy here at Curinos. Welcome, Adam, to the podcast. Before we dive in to talking about deposits, can you tell us what your role at Curinos entails?

Adam Stockton: Absolutely. Thanks, Rutger. I'm really happy to be here. My role at Curinos is all about helping banks, grow deposits, forecast their deposits and price their deposits.

Rutger: That's pretty clear to me. Again, thank you for joining us today. We all heard, of course, recently that the Fed raised the rates, and most likely that there's more rate hikes coming. What is the market currently expecting for rates throughout 2022?

Adam: Absolutely. Right now, the market is expecting more increases. The Fed said that they were going to keep increasing rates as long as inflation is high. Now, most observers expect the Fed to get to somewhere between 200 and 300 basis points by the end of the year. That's somewhere between 2% or 3% in terms of the Fed funds target rate.

One other thing I would say there is expectations can shift really fast. Back in January, it was looking like we were only going to get two or three increases this year, and the Fed was going to be at 75 basis points. We're already there right now. Right now, the market's expecting between 2% and 3%, but who knows where we'll be as the next inflation numbers continue to come out?

Rutger: Now, corporate and consumer deposits flooded into the system during the pandemic. What do bank deposit coffers look like right now? How much does that vary bank to bank?

Adam: Yes, those deposits are still there. It's really amazing. I think everybody that we talked to was predicting that a lot of those deposits would flow out pretty quickly. The stimulus was designed to be spent and stimulate the economy. It turns out a little bit of it was. About a third of the EIP stimulus to consumers was spent pretty quickly. The rest of that money, that two-thirds, has stuck around for a long time. There is some variation bank to bank, so not every bank has a lot of extra. Those funds tend to be within primary checking accounts, but the industry as a whole is still sitting on trillions of dollars of excess deposits.

Rutger: Yes, that search really stuck around. Now, what's your current thinking about deposit levels for the rest of the year?

Adam: As of right now, there are a lot of pressures on deposits in terms of quantitative tightening, first and foremost, which basically means one of the ways that the Fed stimulated the economy was by buying a bunch of assets. That basically pumps money into the system because when they bought those assets, they printed new money to buy those.

What quantitative tightening really means is they are selling those assets to others, and when the money comes back to the Fed, it goes out of the system. We are expecting to see deposit levels under pressure because of the quantitative tightening. Then on the consumer side as well, we are seeing increased spending levels. People who didn't go, or haven't gone on a vacation for the last two years, summer travel bookings are way up.

Then inflationary pressures as well, where so far price inflation has risen faster than wage inflation, meaning people have to spend more money on goods and services than is coming in the door. All of those things point to at least a slowdown of deposit growth, if not some modest deposit runoff.

Rutger: Now, how is this rising rate cycle different from the previous cycles?

Adam: Yes. This cycle is shaping up to be very different than the last two. The last two cycles actually look quite similar in a lot of ways even though the pace of Fed moves was different. In 2004 to 2006, the Fed increased rates by 25 basis points at 17 consecutive FOMC meetings. In 2017 to 2019, it was a much slower pace of Fed increases. The big difference that we're seeing this time is those excess deposits that we just talked about.

One of the common threads between the last two cycles was almost every bank going into those last two rising rate cycles needed to raise more deposits. They were looking for really aggressive growth. Therefore, when you're looking for aggressive growth in a rising rate environment, you need to pay increasing rates in order to get it because, today, somebody might walk into your bank for 75 basis points.

In four months, that same customer might be looking for a 125 or 150 basis points, in order to switch banks. In this cycle, because of those excess deposits, we're seeing a lot less need for growth. If banks don't need the deposit growth, if they don't need new customers walking in the door, they may not have to increase rates as quickly in order to get that growth.

Rutger: You mentioned the FOMC. For those not completely familiar with that, what does that stand for, Adam?

Adam: Absolutely. That is the Federal Open Market Committee. That is the policy arm of the Federal Reserve, comprised of some of the-- the Fed chairman and some of the governors of the regional Fed banks who set that policy interest rate. Really, what they're trying to do is by increasing rates, that slows down the economy and slows down inflation. It really prevents the economy from overheating and getting us into a big inflation cycle as we saw in the 1980s where prices spiraled out of control, is the biggest thing that the Fed is looking to try and control through the FOMC by increasing interest rates.

Rutger: How have banks responded to higher rates so far? How can they best be positioned for this cycle?

Adam: For the most part, it's been fascinating. Banks have done very little. Now, that is, in some ways, consistent with what we saw in the last two cycles. When we exit from a low rate environment, banks profitability on the deposit side of the house is a bit squeezed. If you think about how banks make money, banks take in deposits and pay customers for those, and then they lend the money out at higher interest rates.

When interest rates are low, those net interest margins are squeezed across the board. If you think about when rates get higher-- In particular, checking deposits, which are usually not paying interest-- banks have those portion of checking deposits where they're able to loan out money. It may be 5% or 6%, and they're paying no interest on the checking deposits. Net interest margins, particularly on the deposit side, expand in a rising rate environment, and so banks are looking to get some of the profitability back early on.

With that said, as I mentioned earlier, the biggest impact is the excess deposit levels that they have. Banks just don't need the growth, and therefore, they don't need to pay up to get it. That's not true across the board. Not every bank has excess deposits, but we really haven't seen any significant moves yet. We're seeing a lot of banks try and wait as long as they can given that they don't need the growth.

Rutger: Yes. It's also up to the banks to decide, right, how they set their deposit rates. Whereas, most of the lending products, or at least some of them, are tied to a benchmark, so they automatically go up, right? If you have prime rates on the lending side, and the prime rate goes up when the Fed funds rates goes up, it automatically goes up. Obviously, banks have a little bit of a benefit. If that goes up, and they can hold back a little bit on the deposit rates not increasing as fast, that makes them a little bit of extra margin.

Adam: Very large companies are able to negotiate with banks, because their deposits are so huge that they can say to banks, "Sure, we'll bank with you, but only if you give us a rate that's tied to Fed funds." Your average consumer doesn't have that negotiating power with banks. Banks say, "On savings and money market accounts, we can change our rates at any time in our sole discretion," and that's what they're doing.

Rutger: What about fintechs and direct banks?

Adam: You found one of the few segments of the market that actually is responding. It's interesting. The direct banks or online banks, we tend to use the terms interchangeably, really are one of the few segments of the market that don't have those access deposits. When we think about the access deposits, or surge deposits, those really went to primary checking accounts.

If you got an EIP check, that went into the account that your tax refund goes into, which is usually your primary checking account. If you didn't spend money during a lockdown, well, you still had, hopefully, the same amount of money coming in that you just had less going out. Again, most of that surge has built up in primary checking accounts. A lot of the online banks don't have primary checking accounts, and so what you're seeing is a much lower level of growth over the last couple of years. Therefore, those are the banks that need to grow.

For some of the fintechs, they're starting out with no deposits, and they really see this as an opportunity. They say, "We're trying to expand our customer base," and, "Hey, if nobody else is going to pay rate, this is great. We'll see if we can take customers from some of the traditional banks in the same way that getting paid two days early." Getting rid of some of the overdraft fees was really an opportunity to attack some of those profit pools of traditional banks. Paying interest could be another one in this type of environment.

Those online banks have been more aggressive so far. A lot of them have already increased their savings rates by 10 to 20 basis points. We've seen CD rates increase even more for the longer-term CDs in excess of 50 basis points. For consumers looking for more interest, the online banks are one of the bright spots right now.

Rutger: What should institutions do when customers start demanding higher rates?

Adam: Yes, that is the million-dollar question, is-- If you think about the position that the banks are in, it's a really tough position where they want to keep the customers, and they want to keep the relationships, and they want their customers to be happy, right? Banks need their customers to bank with them, and to keep as much of their wallet with them in the long term as they can in order to stay growing and stay profitable in the long term, but they don't need the deposits right now.

Unlike the last two rising rate environments where banks needed the deposits, and so if you came in and said, "Well, I can get 2% across the street. What are you going to do for me?" Most banks said, "Yes, of course, we'll give you 2% as well." This time, they might not. It's the same as if you think about calling your cable company and saying, "Hey, can I get a break on my deal?"

T-Mobile's running a special where they'll give me a mobile phone for $50 a month. Sometimes your company will say, "Yes, you're a valued customer. Sure. We'll take $30 off your bill." Sometimes, they'll say no. I think that's really where banks are going to be this time around, is they want to keep as many customers as they can. Since they don't need the deposits, they won't be able to keep everybody. Trying to think through who are the customers that were willing to pay extra to keep or to grow is a much more challenging question this time around than it was in the last couple of cycles.

Rutger: Yes. Then leading from that, is there a point at which corporates and consumers start shopping around for higher rates? First, you responded like, "Hey, what if they demand with the bank that they're with?" At what point do they get triggered to go shopping?

Adam: Looking at our historical data, and we track lots of data from both the consumer side and the bank side, what we've seen is there a couple of big tipping points. One of the biggest ones is around 1%. This aligns with a lot of consumer pricing psychology and behavioral economics more broadly. It's why on the flip side, you always see prices that end in 99 cents because to somebody Seeing $9.99, that just triggers less of a response than seeing $10. It feels like less.

It's the same thing on the other side with the deposit rates where, if somebody's seeing, "Oh, I could get 1% on my money." That just feels very different than I could get 0.95%. "I don't know. There's a zero in front of it. Is that really going to add up to anything?" 1% is where we start to see the behavior shifting, and that 1% can come in in a couple of different ways.

The first one is the absolute rate that a bank is offering. Once those online banks start offering a rate that starts with a one instead of starting with a zero, that is going to prompt some customers to look up and say, "Oh, I could get a good rate." The other place that it's going to make a difference is the difference in rate between what a customer is getting today and what they could be getting somewhere else, right? That gap between where I am today and where I could be is the other important side of things.

We also see other tipping points every time a new level is crossed. It's a little smaller than crossing 1%, but going past 2% is another big tipping point. It actually turned out the biggest tipping point in the last rising rate environment. We saw a lot more customers switching once rates got increased above 2%.

Rutger: Yes, so that's important, that symbolical 1%, or symbolical 2%, and then how often it's in the news as well, right? I'm sure that when people read the paper or look online and say, "Hey, Fed raised the rates again." even if they're not fully aware where it is. More often they hear that the more they will be woken up and start thinking about, "Hey, maybe I should look at what I'm getting on my deposits." Now, are different customer segments responding differently to rising rates?

Adam: Very differently. They're always. Everybody responds differently. One of the ways that we measure that, we call rate sensitivity or elasticity. Some customers are just happy where they are and they're not really looking for additional rate. Interestingly, it has less to do with the amount of money somebody has than you might think. It's really an attitude towards money.

We see some people even with lots of money who don't look at the rate on their deposits, in part, maybe because they have a big portfolio of investments. They say, "My investments are what I need for growth. My deposits are just an emergency fund. I'm not paying very close attention to what they need to grow." You see, other people who look very closely and are constantly checking the market, "Could I be earning even five basis points more than I am today?" so there are big customer segment differences in terms of behaviors and attitudes.

There are also some broader customer segment differences based on other attributes too. Certainly, some customers who have big investment relationships have other alternatives, money market mutual funds, or bond funds or other investments that they're comparing their deposit rates to. That's the flip side of the behavior that I mentioned earlier where some say, "My investments are for growth, so I don't care as much about my deposits." Others say, "Well, hey. If I'm making this much on my money market mutual funds, shouldn't I be making that much on my deposits too?" We see very different behaviors and very different segments across the market.

Rutger: It's going to be crucial then for banks to understand the different segments and how they behave to changes in deposit rates to manage those surge deposits as the rates in the markets go up. Is that correct?

Adam: That's exactly right, coming up with different strategies for those different segments. If you have somebody who's always asking for the best price, how do you think about interacting with that customer versus somebody who might just come in once or twice a year, maybe when they get a tax refund or a Christmas check and want to put that money to good use? Banks are going to need different strategies to think about that. In some cases, given how much extra deposits they have, they may have to tell some customer segments.

"We're just not willing to price up as much this time, because we don't need the deposits. We don't have enough loans to put those deposits against. If we can't do anything with them, we're just not willing to pay as much. The one thing I would add is, as banks are coming up with plans to retain customers and figure out who to give different rates to-- What is a strategy that makes sense today it may look very different three months or six months from now, depending on what the Fed does with the quantitative tightening that we talked about earlier how the competitive environment looks.

Banks are really going to need to stay on top of who is asking for more rate, who is starting to leave, and be ready to shift strategies. In fact, we may need to see some banks who shift from, "We have more deposits than we need," into, "Oh, no. We've got to start growing and identifying that early and figuring out how to easen to growth instead of trying to go from zero to sixty overnight is going to look a lot better right now.

Rutger: Yes, that makes perfect sense. Now, finally, we were asking each guest on the podcast, what is a term or an acronym or lingo that you would like to retire or redefine? Something that you hear a lot and you say, "Well, I'm tired of it," or, "It's not used correctly," What would be that term for you, Adam?

Adam: We've been talking so much over the last two years about surge deposits, the extra deposits that came in through the pandemic. Ultimately, this is a term maybe not that we'd like to retire, but it's going to retire itself at some point. Our perspective is there's going to be a wave of spending this summer. After they do that, for the people who haven't spent for those deposits that stick around, at some point, we're not going to be able to call them to surge deposits anymore because there's going to be an expectation that some portion of those become permanent instead.

I think by the end of the year, we'll have a lot more clarity on what portion of those excess deposits are sticking around versus not. What sticks around is ultimately, in a large part, going to become part of the normal banking system as opposed to surge. I think that one's going to really retire itself at some point over the next 6 to 12 months.

Rutger: Well, that's a great answer. You don't want to retire it but it will retire itself. I think that's a great way to end today's podcasts. You also brought us a (f)insight fact, which I think is very interesting. Top CD rates from direct banks have risen 57 basis points, a little bit over half a percent since October for 48 months CDs, and 63 basis points for 60 months CDs. That, I think, is a very interesting fact and something to keep an eye on because it's probably changing all the time.

Thank you again, Adam, for joining us today. I'm Rutger van Faassen, and this has been the Curinos (F)insights podcast, helping you navigate today and anticipate tomorrow.

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Rutger: As always, thank you to our Curinos (F)insights team. Robin Sidel is our Director of Thought Leadership, editing and production by our senior designer Adrienne Cohen. Project management by our Marketing Communications Manager Meagan Brezette. Music is by vizion-studios. I’m your host, Rutger van Faassen. You can find more insights at curinos.com. Please subscribe and review wherever you listen to podcasts.

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