The global response to the financial crisis was the lowering of interest rates in order to stimulate spending and borrowing. Traditional economics suggests that lower rates encourage consumers to spend their savings, businesses to invest in their business, and both to borrow to enhance their lives or expand. But there is nothing traditional about the seven-year financial crisis and behaviors have dramatically changed.
As deposit interest rates fell, consumers and businesses held their cash out of fear that they may need it as unemployment remained high and businesses failed. Consumers stopped borrowing as they deleveraged and banks remained cautious about new lending. So instead of low interest rates stimulating spending, borrowing, and general growth, the impact has been largely stagnation. An animal that hibernates doesn’t wait until the snow comes to start gathering food; why are banks waiting to start implementing price optimization strategies?
Are we seeing signs of change yet?
After a number of false starts, we are indeed seeing signs of a more lasting effect of low rates. Construction spending is increasing. This will stimulate consumer purchases. The personal consumption index, excluding food and energy, has risen and consumer lending has seen a small but steady increase. Perhaps not sufficient for an immediate Fed increase, but a preamble for changes in the latter part of the year.
Many banks are still breathing a sigh of relief having reduced deposits rates over the last few years to close the negative jaw. In this benign period, with a clear sign that interests rates will start to recover, many banks are asking “why now” when it comes to investing in deposits price optimization strategies. Their reasoning:
Interest rates remain low, and even though the Fed is predicting increases, no one can tell for sure when that will happen.
There is little scope to improve margin in the current environment.
Asset growth has been subdued and banks have excess liquidity.
But it is now that banks need to deploy such strategies. It is the only way to ensure that they maximize the benefit to them and their customers ahead of changes. An animal that hibernates doesn’t wait until the snow comes to start gathering food. In the same way, banks need to prepare for the next phase of the cycle and execute a portfolio optimization strategy that allows them:
To deeply understand depositor behaviors, through data, over the last number of years. Understanding price sensitivities and tradeoffs (e.g., between access and return) in a downward cycle is a barometer for upward changes).
To execute test-and-learn strategies to understand the changing impact of price in the market and use this to better forecast future behaviors.
To understand new, changing, and dynamic micro segments to help inform product, pricing, and channel strategies.
To accurately forecast the impact of leading the market, lagging the market, or following the market when rates change.
To allow the bank to act definitively and swiftly when changes occur, thus saving time and costs.
To ensure the bank protects the repair of deposits pricing of the downward cycle by effective pricing in the upward cycle.
The differences between banks that have invested in price optimization solutions and those that have not are clear. Those that have invested already have clear, planned actions for when rates change. They will benefit from knowing what to do and when to do it, rather than the traditional approach where they would question their strategy after it’s implemented.
It’s not a question of whether banks should adopt price optimization strategies; it’s a question of what are the consequences of not adopting one.
Damian is a career banker with more than 25 years of experience. He spent most of his career with Bank of Ireland where he held a number of senior roles, including Head of Deposits and Current Accounts, Head of SME Banking and Head of Customer Management and Customer Analytics. At Nomis, Damian is Managing Director responsible for the APAC region.