The move suggests that the cost of retail deposits at digital banks has likely reached a peak in the first quarter and will start going down if the Federal Reserve cuts interest rate this year as anticipated, according to industry experts. The effective federal funds rate has been flat since July 2023, and market participants have pushed their projection of the first rate cut to September, later than many originally thought.
The deposit pricing gap between online banks and the overall banking industry has narrowed noticeably for the first time since the rate hikes, TD Cowen analysts wrote in an equity research note May 7. Among digital banks, rates of one-year certificates of deposit (CDs) have declined broadly, and savings rates have also started to decline, though to a smaller extent.
"This is a positive sign of easing competition in deposit pricing, and the next validation would come from a broader decline in savings rates (particularly from the rate leader), which usually move after CDs in each up/down cycle," the analysts wrote.
Goldman Sachs Group Inc., American Express Co., Capital One Financial Corp., Discover Financial Services and Ally Financial Inc. are among the banks with large digital channels that have lowered the annual percentage yields (APYs) on high-interest online savings accounts in May, compared to their rates in February, according to data compiled by S&P Global Market Intelligence.
"The interesting thing is that these banks have already started to lower rates even though rates haven't gone down yet," TD Cowen analyst Moshe Orenbuch said in an interview.
In the early innings
Several digital banks that lowered deposit rates in the first quarter said they expect deposit rates to trend downwards from now on among banks with little branch operation.
Synchrony Financial, which added $3.4 billion of core retail deposits in the first quarter, has lowered the rates for 12-month CDs by 50 basis points compared to the fourth quarter of 2023, although savings rates remain unchanged.
"We believe we peaked on interest-bearing liability costs from here," Synchrony's executive vice president and CFO Brian Wenzel said during an investor call in April.
Ally Financial also "took meaningful actions to reduce deposit pricing" in the first quarter across CDs and its $100 billion liquid savings portfolio, CFO Russell Hutchinson said during an April 18 earnings call. Lower deposit costs are expected to contribute to an expansion of net interest margin (NIM) starting in the second quarter, Hutchinson said.
Still, it is too early to build a definitive correlation showing lower deposit rates' impact on the bank's NIM, Hutchinson added.
TD Cowen's analysts said Capital One and Discover Financial are the digitally oriented banks likely to face the most headwinds from a down rate cycle, although Capital One's branch network would help alleviate the impact on the digital side. Both companies have lowered online savings account APY to 4.25% as of May 6.
Deposit competition still heated
Although online banks have started acting proactively, the competition for deposits is still fierce. The current reduction of rates only touches the surface of deposit flows in the industry, as funding costs remain high in the first quarter of 2024.
"If you look at the blended average of the cost of deposits across banks, there's still probably pressure as people who haven't repriced their deposits begin looking at that — most have," said Mac Thompson, founder and president of White Clay, a revenue optimization platform for banks. "Where the reduction is coming is more on those outlier balances trying to get those very high-end rates."
Because the high rate environment has lifted depositors' expectations on rates, banks of all sorts will likely have more difficulty retaining customers when rates start to go down, since customers used to high yields could be more sensitive to rates, said Val Srinivas, banking and capital markets research leader at Deloitte US.
"The psychology has changed so dramatically in the last 1.5 years since rates started rising. So I don't know if [deposit costs] are going to draw back as much as people hope," Srinivas said in an interview.
Competence lies beyond rates
Ultimately, APY is only one piece of the puzzle and lower rates do not guarantee success for digital banks to build sustainable and long-term growth.
"You can't just turn on the deposit acquisition machine and let it run endlessly," said Charles Potts, executive vice president and chief innovation officer for the Independent Community Bankers of America. "You've got to have the right investment products. You've got to have the right lending opportunities. So you can't just focus on the speed at which you change rates," he added.
Goldman Sachs' retreat from consumer banking illustrated the challenges if a digital bank's deposit acquisition is not paired with an effective deployment strategy, Potts noted. The investment bank pursued retail deposits through its digital banking brand Marcus, and entered consumer lending through Marcus and an acquisition of home improvement lending platform GreenSky Inc. But the lack of profitability in consumer banking eventually prompted Goldman Sachs to sell both GreenSky and the personal loan portfolio within Marcus. The future of the firm's credit card partnership with technology giant Apple Inc. is unclear.
Another challenge faced by digital banks, unlike those that use branches to retain customer relationships, is retaining customers who may be inclined to chase after higher rates.
"I actually sometimes wonder when the pure digital bank plays might start adding elements of brick-and-mortar, either through partnerships or on their own, but just be able to retain some of those extremely high-end clients," White Clay's Thompson said.
