Deposit retention and growth is strategic priority #1 in the banking industry today. But although financial institutions need a long-term strategy for a near-term challenge, playing the “rate game” is a race to the bottom.
Finding growth has been a rough slog for banks and credit unions throughout 2023. Since the peak in the second quarter of 2022, deposits in the banking industry decreased $774 billion as of Q3.
To maintain funding to grow loans, banks and credit unions have turned to the “ol’ reliable” funding strategy of opening up the certificate of deposit faucet to fund growth. Since Q2 2022, the mix of CDs to deposits doubled from 8% to 16%.
This funding shift is occurring at a time when interest rates are at their highest level in over 20 years. This combination of challenging growth and expensive deposits has caused a surge in funding costs. Just one year ago the cost of funds was a paltry 0.59%, but it jumped to a staggering 2.18% in the third quarter of 2023.
While there is no question that deposit growth is slowing for the industry, some institutions have managed to string together four quarters of consecutive growth. Cornerstone analyzed the roughly 1,400 banks and credit unions with between $1 billion and $50 billion in assets and identified 115 banks and 51 credit unions that fall into this enviable group that we’ll call the “4Q Club.”
While CDs have still played a part in their growth story and funding costs have increased across the board, a deeper look at institutions in the 4Q Club reveals some common characteristics that may help to explain how these institutions have bucked the trend and sustained growth through 2023.
The key to winning in today’s digital-first world is a focus on experience. People want things fast and easy with as little friction as possible. When it comes to deposits, having the ability to allow customers to easily open an account on their own terms when and where they want is critical. That is the reason digital account opening has been one of the hottest solutions for selection or replacement over the past few years according to Cornerstone’s annual “What’s Going On In Banking” research.
As an industry overall, only 43% of banks and 48% of credit unions have an automated DAO solution in place.
For the members of the 4Q Club, the gap closes considerably with 81% of banks and 100% of credit unions having a solution in place. Of course, simply having a DAO solution will not drive growth, it is simply an enabling capability.
Success requires an organizational effort to drive growth that involves marketing, sales and operations. In addition, not all DAO solutions are built the same and experience can vary, which is why many leaders in the 4Q Club have sought out best-of-breed third-party systems to provide the greatest experience possible.
One interesting characteristic is the prevalence of relationship-based rewards tied to checking products at 4Q Club institutions. These products go beyond the attractive interest rates of a high-yield checking account (although that is sometimes included). Instead, these programs offer debit rewards based on spending, value-added services (like cell phone protection, identity monitoring and roadside assistance) and preferred rates (including loan discounts, savings rate boosts and fee waivers).
For members of the 4Q Club, an impressive 41% of credit unions and 30% of banks (which have typically not had as much of a focus on retail banking) offered a rewards program tied to a checking product.
What makes these programs effective for growing deposits is they often require some form of minimum deposit balance, which promotes consumers holding more money in these (relatively) low-cost accounts. They also incentivize and reward loyalty, engagement and deeper product depth by design.
Implementing a rewards program takes a long-term commitment. Some institutions have developed their products in-house while others have opted to leverage a third-party partner such as Kasasa or BaZing. Banks and credit unions considering a rewards program need to understand the business case, scrutinize assumptions and ensure it makes sense for their target market.
An overwhelming majority of banks and credit unions that we have worked with recently for strategic planning identified business banking as a strategic opportunity. The challenge we tend to see, however, is that when banks and credit unions embark on this journey, too many focus only on the lending opportunity. The reality is that 60% of small businesses don’t utilize credit, meaning the real opportunity for business banking lies with deposit acquisition.
While business deposits are not broken out from total deposits in a bank’s regulatory filing, we can use commercial and industrial loans as a percentage of total loans as a proxy to determine banks with business models more likely to engage in business banking. If we lead with that assumption, banks in the 4Q Club have a 15% higher C&I loan mix than their broader banking counterparts.
Credit unions, on the other hand, do report business deposits separately. For 4Q Club credit unions, business deposits (as a percentage of deposits) are 20% higher than the average credit union between $1 billion and $50 billion in assets.
While implementing efficient lending processes is certainly important for success, banks and credit unions need to prioritize the development of tailored small business deposit products to capture their share of where the business banking opportunity truly lies: deposits. Attacking this market requires recognition that digital services are vitally important in serving this market, as more business owners want the ease of use delivered on consumer mobile banking platforms.
Banks and credit unions need to develop a long-term strategy for what they may only view as a short-term challenge. Reliance on a CD-centric funding strategy will not be sustainable in this new environment. While there is no “silver bullet” when it comes to sustainable low-cost deposit growth, these three characteristics of higher performers may provide some effective ammo to consider when developing an effective, low-cost deposit growth strategy.