The Federal Reserve’s signal this week that it will start raising interest rates in March 2022 generated a collective high-five throughout the banking industry. Bankers have been poised and waiting for interest rates to rise as they are counting on reaping the rewards of an asset-sensitive balance sheet. However, without proper planning, the joy may be short-lived. The Fed news should give bankers even more reason to consider their asset/liability management (ALM) and deposit management strategies, policies, and programs.
Coming rate hike should nudge bankers to focus on deposit management strategy
January 27, 2022
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Higher fed rates ahead: Plan now to manage impact on deposits
The Fed's signal of higher interest rates reiterates the importance of financial institution ALM and deposit management strategies, policies, and programs.
Takeaway 1
Without proper ALM planning and deposit management, the expected Fed rate hike might not generate expected rewards.
Takeaway 2
If the market trends downward for long, banks and credit unions could actually see another increase in deposits.
Takeaway 3
Institutions should plan product and pricing approaches so they can price deposits profitably during this period.
Interest rates
Tighter Fed policy puts ALM in focus.
Generally, bankers expect the yield on earning assets to increase sooner than the costs of their deposits. However, if a financial institution is to capture any of the projected economic growth moving forward, core funding is key, so now is actually a good time to look at growing deposits.
“Core funding is key, so now is actually a good time to look at growing deposits”
Depositor behavior
Market volatility could generate another surge.
One risk in growing deposits is the risk that the current depositor mix includes a level of “surge deposits” that, while core in nature, are not well defined in terms of price sensitivity. To retain the surge, and grow new funding, institutions may need to increase rates paid to depositors sooner and more-than-projected. Otherwise, they risk losing funds and customer primacy to competitors, the stock market or other investments as depositors seek even higher yields.
However, in recent weeks we have witnessed uncertainty on Wall Street about tighter Fed policy, inflation, supply chain disruptions, labor shortages, and the pandemic’s longevity. The Dow Jones Industrial Average (DJIA) is down more than 6% over the last month, and some analysts are projecting lower returns from equities over the next decade. Plans for aggressive rate increases and a suspension of asset purchases have many firms projecting slower growth and reduced yields for equities.
Stay up to date on deposit management strategies.
If the market trends downward for long, banks and credit unions worried about money walking out the door might be surprised to find that does not happen. Financial institutions may see yet another flight to safety from investors looking for certainty after enjoying a good run in the market. As a result, financial institution deposit levels may increase yet again — a surge on surge!
Deposit pricing & mix
What’s your deposit management strategy?
Pricing the existing deposits profitably while considering the potential new surge requires institutions to have a strong plan thought-out in advance for product and pricing approaches to manage marginal costs. They also need to act quickly on deploying these funds into appropriate assets to manage the margin.
How will a financial institution know which customers will do what, and how to take advantage of the opportunities presented?
Understanding the makeup and behavior of depositors over time through various cycles is key. This understanding across cycles needs to include:
- Attributes related to demographics, generational factors, and relationships
- Market rate correlations to pricing, and
- Rate sensitivity.
Get the latest best practices for managing interest rate changes.
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About the Authors
Susan Sharbel
Senior Consultant
Susan Sharbel brings over 35 years of expertise in the banking industry, with a focus on asset/liability management and regulatory compliance. Prior to joining Abrigo, she was an ALM consultant leading ALM model implementations and managing the quarterly ALM process, support, and analysis for nearly 40 banking clients. As a
