The Importance of Managing Core Deposits
“I don’t think there’s any more important topic at this time in our recovery in the economy and the state of community financial institution management,” said Dave Koch, Managing Director of Advisory Services at Abrigo on the topic of core deposits. “Deposits are a thing that we have coveted for a while and became quite easy. Now once again we’re back to the question of, where do I go to get more deposits? It’s a challenging and vexing business in a strong and growing economy.”
There are three, successful deposit management strategies that financial institutions can use to update the assumptions in their asset-liability models and to satisfy internal and/or regulatory requirements, according to Koch in a recent webinar, “Analyzing Core Deposits for Risk Management and Loan Growth.”
Understand the makeup and behavior of your depositors. An institution should be able to look at the kind of actions that they have taken and determine what the demographics and behaviors of their depositors are today. The depositors of today look different than the depositors of 10 or 15 years ago. An important question to research is, “What makes this depositor engage with us?” This new class of depositors expects different kinds of conveniences, like online access and easy transfer of money with technology. This changing depositor landscape is shifting the strategies utilized for successful deposit management.
Develop your pricing strategy relative to the behavior of deposits. After figuring out who the depositors are, it is important for a financial institution to have a firm idea on a pricing strategy. This includes knowing if an account will be stable or reactive to specific market conditions. Financial institutions are looking for stable deposits that are not sensitive to pricing; however, it is unlikely that deposits will behave in a steady manner. It is more common to have reactive money, which is caused by people demanding to receive the market rate when rates are higher. Although this situation can be manageable, it is important to identify the split of price-sensitive and insensitive deposits. How can a financial institution keep depositors engaged on levels other than price?
There are a lot of depositors who choose to go with other financial institutions not solely because of price but based on what they get from the relationship. Specific perks include cashback based on the number of transactions, free on-line banking, and other rewards. A financial institution should learn more about those benefits are and identify whether it will be profitable to incorporate those relationship-building strategies into their lines of business.
Understand deposits’ impact on the balance sheet. Lastly, for an effective deposit management strategy, there should be an awareness of how deposits act on balance sheets. From a contractual term, deposits can look different than how they are being used in practice. On paper, non-maturity deposits are short-term contracts that can be canceled with the stroke of a pen or a click of a mouse. Yet, in practice, it’s much more common for these deposits to have a long shelf-life, and leadership should still be able to identify how this money can be leveraged and what can be funded by their deposits. In order to do this, a core funding duration or life should be calculated so that deposits are allocated in a way that continues to accomplish the overall institutional mission, which is providing excellent credit services to the market place.
How a Core Deposit Study Can Help
A core deposit study can help financial institutions understand the characteristics of their depositors, help develop better pricing strategies and gain more insight into their deposit portfolios.
The study itself is a review of past trends in deposit levels to assess behaviors of both depositor and institutional activities that impact overall funding stability and price control. It requires a look back at long-term deposit trends and pricing actions within a sector of accounts. A quantitative analysis of balance and account trends is coupled with experience-based qualitative analysis of interactions, which include both institutional and market influences. The goal is to determine the levels of funding by sector that are stable sources of funds and less volatile in price, in addition to establishing account longevity.
“A core deposit study is beneficial not only for identifying the impact of a depositor relationship but also for identifying the financial institution’s own behavior,” Koch said on the webinar. “For example, if an institution has raised rates on all its products because interest rates have gone up, they have made the accounts price-insensitive based on their own actions. If you always paid me the best rate, why would I ever go anywhere else? But when you don’t offer a higher rate, I must think about whether to move my money into a different place at your institution or switch to a competitor.”
Some insights gained with a deposit study include
- Knowing how price-sensitive depositors are
- Understanding how many accounts are closed in a period
- Determining how many account holders reduce or increase their balance over time
“The results of a core deposit study can inform product design. It defines the types of demographics to go after, it informs the types of investment in technology that a financial institution is making, and what the realistic timeframes are for those specific goals,” said Koch.
“2020 budgets are just around the corner. We need to start planning for deposit growth to happen. We need to start with understanding who our current depositors are now so that we are set to bring the products to market that we need.”