Many banks work hard to have a low-cost deposit base only to undermine their efforts. One of the biggest mistakes banks make is to advertise an above market rate thereby not only shortening deposit duration and increasing negative convexity for that one account, but for the whole product offering. Note the subtle distinction that might be lost on many inexperienced bankers – while the rate impacts an account, the mere advertising also impacts the account. It gets worse.
Maybe The Customer Is Worth It
Consider a money market account at a bank. In order to keep a customer with a $75,000 balance, the account representatives extends a rate of 1.75%. In today’s market, that rate is competitive with the top paying banks and is far above the nation’s 0.15% average bank rate for April. That 1.75% money market account likely has a duration of 0.18. This means that when rates go up, the account isn’t going to gain in value and that the rate on this account will most likely go up as well to keep the money in the account. While this isn’t great, it is not the worst thing as maybe the customer is worth it.
But, Maybe The Whole Deposit Base Isn’t
However, our point today is that as soon as you post a rate, that makes all other accounts more interest rate sensitive and results in cannibalization. Money from not only other money market accounts come in, but money from checking, savings or 3 month CDs flow into this account. The higher the rate and the better you are at advertising, the more value your bank will lose in deposits. The big point here is that when you set and advertising a rate on one account, it could have a negative impact on the entire deposit base multiplying your cost, sometimes geometrically.
Does It Work In Reverse?
Of course, posting a lower than average market rate should have the opposite effect, right? Yes, posting a lower than average rate compared to the rest of your deposit base allows other deposit holders to feel special about their rate and aids in retention. The problem is, again, the mere act of advertising rate shortens duration over time no matter what rate you post. While duration will increase on some deposit accounts if you post a lower rate than they currently enjoy, many of those accounts will then start to focus on rate and become more rate sensitive. The net result is while posting a low rate may help for a short period of time, over a longer period of time, banks posting any rate train their accounts to be more rate sensitive.
The Worst Part About Rate Advertising
While advertising on rate has a detrimental impact on deposit performance, where the real unseen tragedy lies in what advertising a rate does to employees. Post an aggressive rate and the whole staff starts to believe that rate, not service is the most important. Talk to almost any employee at Ally Bank or Capital One and they will crow about their deposit rates. Ally and Capital One can get away with this because of their business model but most banks can’t.
Once a bank’s staff learns that rate is important, it is hard to change internal behavior as it can take years. In the meantime, employees teach other employees and customers about the importance of rates. As they do, deposits become more sensitive and a bank loses value.
Putting This Into Action
Now is the time to be extremely careful, as having low rates for so long has made the average bank depositor less sensitive to rates in general. By posting any rate, we end up training our employees and customers to be rate sensitive and introduce a price element to your deposit base. It is far better to stay away from advertising rate entirely. Market any other aspect – service, flexibility, community, branches or other aspects of your bank’s value proposition. Doing so will only dissuade the more rate-sensitive customers while attracting those customers that are non-rate sensitive. The result will be a better performing bank for years to come.
Submitted by Chris Nichols on April 19, 2018