the first 200 basis points, but by the third and fourth hundred, the proverbial gloves came off. Rates have now risen uncharacteristically aggressively in a short period – in fact, the delta between market rates and what banks are paying has never gotten this wide this fast. Even if depositors aren’t looking to move their money, it's hard for them to ignore what's happening. Additionally, during the pandemic, we made it easier to do things electronically and conditioned customers to avoid branches. Today, banking practices are very different than three or four years ago. So the dynamics are about to get really interesting, notwithstanding the excess liquidity still out there. What’s your advice to banks? Have a clearly documented game plan. (Many banks don’t.) Start by figuring out how much money you can, or are willing to, let leave; then determine which deposits are most valuable and prioritize those. Next, divide your deposit base into manageable pieces. Start by rank-ordering your largest-balance relationships (this will help with one-off conversations). Second, review your mass-market, traditional banking relationships. Third, review the “tweeners,” or those that aren’t quite whales but larger discretionary balances that could be at risk (mid-tier balances comingled with operating balances in those traditional accounts). Get your people in a room to assess the elasticity of deposits in each sector and your value proposition for those different consumer types, specifically, whether it’s driven by rate or other factors. Figure out your pricing strategy for each and how much outflow you will accept in each area and why. You recently wrote that all banks have what appear to be core deposits but are actually Trojan Horses. What did you mean? Monies that look like core deposits but have a high potential for disintermediation. Municipal deposits are one kind of Trojan Horse. Large commercial balances are another – many businesses have funds sitting in their banks that dwarf what they need for operations, but they’re also facing cost pressures, and it’s hard to ignore the opportunity to pick up the notably incremental yield on their excess cash. If they do need money, many will “borrow” from themselves. The third kind is CDs. CD balances have contracted notably through this cycle, but much of that is CD-mentality money sitting in savings accounts, now accounts, or money markets that will move back into CDs. What should banks be thinking about if rates keep rising? Everyone seems to get overly fixated on rising rates and how high they might go, but no matter what a bank’s interest rate risk profile is, the worst scenario for this industry would be for rates to do an about-face and head lower for three reasons: 1) Funding costs can only go so low, but assets will keep pounding down until eventually everybody’s margins get squeezed – it's just a matter of how quickly and to what degree; 2) declining rate environments are highly correlated with declining economic environments, which are highly correlated with asset-quality challenges, delinquencies, and elevated reserves; and 3) when economic activity slows, the outlook for loan growth darkens. How is social media adding to deposit pressures? It’s definitely having an effect, but banks need to remember there’s always somebody paying more than them. If rate were the most important variable, every other bank would go out of business, and you’d have one bank paying the highest rates. The point I’m making is if banks fuel conversations about rate to where it becomes the main topic of discussion, then they’re communicating that their value proposition is mainly tied to rate instead of the other things they bring to the table. Conversely, depository institutions that believe in their value propositions will do well during this cycle because they’ll know where they can be proactive. They’ll experiment more, try more things. What are your thoughts on strategies for banks not dealing with excess liquidity? I’ll start by saying there are many banks with concentrations of large balances that don’t want pricing on these to upset the apple cart. They don't want a handful of accounts messing up their core deposit strategies, so they've been paying higher rates than usual. Then they've been selling the money into a deposit network, such as IntraFi’s, through its One-Way Sell program. This enables them to effectively lower their deposit costs and keep the money out of their deposit expenses by moving it off the balance sheet, knowing they can bring it back on if necessary. Banks with valuations that reflect a highly inelastic core deposit base through prior cycles don’t want to Have a clearly documented game plan. (Many banks don’t.) January • February 2023 9
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