Stagnant interest rate environment offers opportunity for deposit book growth
Damian Young, Nomis Solutions: Stagnant interest rate environment offers opportunity for deposit book growth
The importance of a stable deposits base has increased exponentially in the post-financial crash era. Since the 2007/8 crisis, retail banks have been forced to address huge balance sheet deficit, brought about by the freezing of mechanisms such as wholesale funding. The reaction amongst the major banks has been to stabilise income sources, growing retail deposits bases by over £250 billion throughout this testing period.
While most European central banks sought to improve customer confidence and instil growth through lowering interest rates (which still persist today), retail banks increased deposit rates during the crisis in a bid to stabilise balance sheets and provide much needed funding. This naturally created high competition between deposit takers and a flurry of consumer activity to chase the best rates.
As deposits books grew and assets were reduced on bank balance sheets, a degree of normality returned. This then changed the focus on repricing deposits in a bid to reduce negative margins on deposit taking. Today the market has reached a historic low in deposit interest rates.
This shift has been an entirely voluntary movement from the major banks. The 2014 Net Stable Funding Ratio, a requirement of Basel III which attempted to force an increase in the reliance on deposits, proved to be quite unnecessary: the target for 2018 was exceeded in H1 2015 by 100%. Utilising this more stable source of funding has brought greater security to the banks and the broader system.
A stagnant interest rate environment offers banks the opportunity to successfully prepare for growth when market conditions change. Pressure on deposit managers is unlikely to alleviate however. The Funding for Lending Scheme (FLS), a major source of funding for most banks, will come to a close in 2018 and banks will look to their deposit managers to fill the inevitable void in funding.
While the scheme has done much to halt the downward spiral of lending in the UK, the relief has, of course, been temporary. According to the BoE, the net amount outstanding from the FLS exceeds £69.5 billion, a figure equal to around 10% of the household savings market. The most recent extension will take the scheme on until early 2018 and banks must be prepared to replace the £69.5 billion, predominantly with income from retail deposits. Natural market conditions will soon return and intensified competition in the deposits market is likely to follow suit.
Deposits remain critical to all banks and as net lending increases, this reliance will be further compounded. Most banks have changed their funding proportions to place a higher reliance on core deposits. Indeed, under Basel III, this reliance is compensated by the value of this funding over institutional or market funding. When interest rates do change, the competition will intensify and banks will see the migration of funds from current accounts to deposits.
Competition for market share in this new saving spree will be intense. The relationships that are formed and cultivated at this point will be a major factor in determining future stability and growth. Although a rate rise is still a number of years off, banks should be using the intermittent time to establish a firm understanding of customers’ behaviours and sensitivities, allowing them to plan for a more certain, sustainable future.
This understanding should be born out of a data-driven approach to changing customer attributes and preferences. The banks already have the required information, but must exercise it to a fuller extent to gain a more qualitative analysis of customer and market potential.
For instance, when base rates change, some customers will simply go for the best rate in the market, whereas others will only switch for a certain rate increase, while other groups will remain with their current bank if they have a strong, secure relationship.
Optimising the portfolio strategy now, using existing market data to accurately forecast customer behaviour, will enable banks to design customer-specific pricing strategies to target their particular preferences.
If banks universally understand what looks good to the customer, they can create long-term, sustainable growth, based on a firm assessment of customer loyalty and retention. Establishing this relationship now will allow banks to build this trust, fulfilling the rest of their customers’ financial needs.
Challenges in the deposits portfolio will become more acute as markets evolve over the coming years. Forward-thinking banks are tackling the issue now with better foundations and frameworks for utilising market and customer behavioural data to design product, channels, pricing and communications.
By Damian Young, managing director EMEA, Nomis Solutions
