So, rates are finally starting to fall. Well, Fed funds came down a bit, but “starting to fall” implies some level of forecasting about the future. The average of the publicly available crystal balls seems to suggest that the Fed funds rate will continue to fall in the medium term through – pick your forecaster – 2026, nestling in around the mid-2% range. Based on the emails I am getting, I gather that financial institutions are motivated to react to the Fed’s signal of a falling-rate environment. What should that reaction include? From a retail perspective, we should adjust our approach to harvesting and managing deposits and loans. This piece will focus on the deposit side; a subsequent article will tackle loan growth. 

Figure 1: Costof Funds vs. 2-YearTreasury Rates

The Impact of Interest Rate Volatility on Cost of Funds Has Been Significant

Source: Raddon analysis of Federal Deposit Insurance Corporation and National Credit Union Administration call report data

For the last 36-ish months, when rates were rising, most financial institutions were timid about raising their rates. The beta in most ALM models was something akin to “mmm, let’s try this . . .” or, in other words, about a 0.6 for credit unions, 0.5 for smaller banks and 0.4 for larger banks (using a lagging-quarter baseline). We were not very aggressive in keeping up with the rate environment. It is likely that our beta on the downswing will be more along the lines of “I am not sure, maybe this much . . .,” or somewhat less than our approach as rates rose. We are likely not to see as much of a reduction in our cost of funding earning assets as we saw a rise. The earnings struggle is likely to remain as consumers continue their rate pursuit after finally seeing their deposit rates rise (for just a few months) following a decade of zero.

This scenario is a symptom of a much larger strategic issue. Since the great banking crises in the late 2000s, financial institutions have forgotten how to manage their deposit products. Sure, some products may vary based on feature (minimum balances, transaction requirements, teddy-bear giveaways), but managing the primary facet of a deposit portfolio, the rates, seems to have gone the way of the passbook-savings account. Because rates were so low for so long, we began to view savings as an input into our lending function rather than as a separate product needing its own strategic management. This is not a criticism of the industry – why wouldn’t deposit management be deemphasized when it has become a commodity priced close to zero? Many of the deposit product managers have participated in the Great Retirement. Can we bring the next generation into the wisdom of their predecessors, who knew how to manage deposits as separate products in their own right?

The issues can be categorized into two groups: How do we keep the deposit relationships we have, and how do we get new ones? For the former, we need to be proactive in identifying deposits at risk. For term deposits, this is easy: when they mature. But realize, the consumer is likely to have already decided to leave weeks before the maturity date. Can we reach out to them before their maturity date to be a consultative, trusted voice as they contemplate their next move in this declining-rate environment? Your depositors will have already received tens, if not scores, of “what the falling-rate environment means to you” emails, letters, phone calls, texts, and conversations with a litany of financial institutions prior to your term deposit’s maturity date. Will our voice be among those, and will ours stand out in the crowd? How well do your platform people communicate with your investments staff? A conversation with a likely departing customer may be able to divert some of those dollars destined for a competitor into your investment balances.

Garnering new deposit relationships in this environment is similar to keeping the ones you have. Most depositors like being near their money. Can you target the depositor close to your various branches? Financial institutions often fear the expansion of product codes; however, a declining-rate environment is a good time to reach out to the market with new products that have an attractive rate without repricing your existing deposits that may be less rate-sensitive. A well-managed deposit portfolio will have a consistent product code cycle regardless of the slope of rate changes, rising or falling. The deposit product code sheet, for management but not the public, should be in a constant state of flux. The status of product codes should be moving from promotional to standard to dormant through the passage of months as the funding needs and rate environment vibrate in the normal course of banking life.

Whenever the Fed announces a rate cut and the topic is on the minds of attentive consumers, you should have a product ready to go. Your marketing channels should be ready to convey the role your institution plays in helping consumers manage their money. Trust is worth a few basis points in rate.

Make sure your operations are up to speed. More and more consumers, even older ones, are opening online accounts with online-only banks. Can our account opening processes for new customers keep up? One of the biggest concerns with opening a new account or a relationship is that it takes too long – are we efficient?

Whew, that is a lot of considerations. All from one little ol’ 50 bp rate cut. Stay tuned as we discuss the lending side of things next.