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Beware of deposit specials

Banking Essentials Newsletter December Edition Part 2

Banking Essentials Newsletter - November Edition

University Essentials | COVID-19 Economic Outlook in Banking: Rates and Long-Term Expectations: Q&A with the Experts

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Beware of deposit specials

Any opinions expressed inthis piece are those of the authors and do not necessarily represent the viewsof S&P Global Market Intelligence. Follow on Twitter @NWStovall.

Depositspecials are coming back in vogue, and small banks might need to be wary offollowing promotional offers made by their larger counterparts.

Smallbanks have already started to see their larger counterparts raise rates oncertain deposit products. The overall changes in deposit rates thus far havebeen minimal, even with short-term rates climbing since the fall of 2015 aheadof the Fed's decision to increase short-term rates late in the year. SNL data shows that deposit rates have only risen a few basispoints through the first few months of 2016. The cost of the industry'sinterest-bearing deposits declined 3 basis points in 2015 from-year ago levels,but those costs appear to be rising at a number of banks with more than $50billion in assets, which are subject to the liquidity coverage ratio, or LCR.

LCRbanks are likely to prize retail deposits as the rate cycle moves forward.Those institutions are required to hold high-quality liquid assets that can bequickly converted into cash nearly equaling or exceeding projected net cashoutflows during 30 days of financial stress. The LCR treats retail deposits farmore favorably, assigning slower outflow rates to those funds.

Anumber of bankers and observers, including SNL, have argued that the LCR will encourage big banksto defend and pay up for retail deposits, particularly as rates move higher. DavidSweeney, managing director at Chatham Financial, said at the SNL CommunityBankers Conference in late March that the industry is starting to see bankswith more than $250 billion in assets offer relationship retail accounts withattractive rates. He said some of those institutions have paid as much as 60 to80 basis points on money balances as low as $25,000. That compares to theaverage rate of 20 basis points currently being offered on $25,000 money marketaccounts, according to SNL data. Customers looking to take advantage of thoseoffers need to swipe their credit or debit card three to five times a month,Sweeney said.

Thosenew offers seemed less common in 2015. The median cost of interest-bearingdeposits at banks with more than $250 billion in assets dipped 1 basis point in2015, but the median cost of interest-bearing deposits at banks with assetsbetween $50 billion and $250 billion actually rose 2 basis points during thesame period. No other group of banks, when breaking the industry down by keyregulatory thresholds, reported increases in deposits costs last year.

Itis commonly held that large banks are rate-setters in the market since theycontrol so much of the deposit market — LCR banks held more than 70% of thenation's deposits at year-end 2015. Smaller banks, meanwhile, are consideredrate-takers and will have to react to their larger counterparts.

Still,some bankers and advisers have cautioned that smaller institutions should bemindful of not chasing after rates and instead focus on building corerelationships. Bankers and advisers in attendance at the WIB Annual Conferencefor Bank Presidents, Senior Officers & Directors on April 3-6 certainlyheld that position, and discouraged the idea of running rate specials to builddeposit relationships. They said any depositor simply chasing rates is not acore customer, and insisted that core deposits remain the true value of anyfranchise. They acknowledged that building core deposits, though, remains oneof the hardest things to do.

ChrisNichols, chief strategy officer at Davenport, Fla.-based 's bank unit,said any bank running a deposit special not only makes their customers morerate-sensitive, but teaches their employees a bad lesson as well. Rather thanencouraging their bankers to focus on the relationship, they are teaching themto focus solely on the rate.

Communitybanks often tout their ability to win new business through superior service. Ifa bank is offering a rate special, the only thing superior a bank is offeringis the rate, Nichols argued.

Smallbanks might not have to be rate-chasers in the near term either. Right now,small banks, those with less than $1 billion in assets, arguably have excessliquidity on their balance sheets, reporting a median loan-to-deposit of 77.12%at year-end 2015. If larger banks increase deposit rates and attract customers,most smaller institutions have the capacity to let some of their depositfunding run off their books.