The Valuable Bank Customer

Over the past two weeks I taught at two separate banking schools. What value do I get from teaching at banking schools? Learning. So often I am trapped with bank executives that carry career-long paradigms with them. Some are beneficial, such as knowing when you should say no to a loan, even one that meets your Debt Service Coverage Ratio (DSCR) hurdle. Some paradigms, however, become outdated because of our changing industry. 

Such is the case for our funding strategy paradigms.

But bankers that are newer to the industry carry no such paradigms. And I was interested to hear how their bank is navigating the challenging deposit environment when they compete with names such as Capital One and Sofi Bank, both of which have much higher-yielding assets than the local community bank and therefore can pay more for deposits.   

I wrote about this extensively in my book, Squared Away-How Can Bankers Succeed as Economic First Responders. Specifically in Chapter 10, The Hot Rate Stalemate. In that chapter, I distinguished between Store of Value versus Accumulation Accounts. One was price sensitive (Accumulation), the other not so much. They key is to have a blend that will deliver a superior cost of deposits. 

This is where the back and forth with students was valuable. The bankers who specifically dealt with deposit customers, either retail or business, discussed the challenges of offering so much less than the Capital One's of the world. Here is an example of what I wrote on the board:

Question #1: What is the value of a relationship? 

Does a customer value the relationship manager and the bank, the branch location, the customer experience, the work you do in the customer's community, and the fact that you lend the vast majority of deposit dollars into the customer's neighbor's home or the local business? 

I think they would, if it is well-positioned, visible, and meaningful to your customer and his/her community. The community bank could do a far better job at positioning the value of your bank beyond price.  Your customers make premium pricing decisions almost daily. Why not for you? 

I don't think, however, that the difference a customer will pay to bank with you versus a competitor is significant. The example above shows a 50 basis points rate difference between Capital One and you, or $500 annually for an account with an average balance of $100,000.  That puts the value of your relationship at 50 bps, which is good except that the average direct operating expenses to average deposits in the hundreds of branches that my firm measures is 99 bps, an expense a branchless bank does not have. Somewhat offsetting this disparity is the average of 35 bps of fee income to average deposits in branches.

Question #2: Is the customer price sensitive in his or her specific account? 

The answer to this question is rarely known but should be discovered during the account opening process (know your customer should be more than a compliance exercise). If not known during the account opening process, perhaps technology could answer this question based on how it is used, or some good old gumshoe investigation by the relationship manager. 

In the above example, Capital One hypothetically thinks the customer is price sensitive in every account. We intuitively know this to be untrue. I have no idea what I'm earning in my checking account or the account that I use to accumulate money for taxes and my next vacation. But if the Money Market Account was my family emergency fund, I would likely want a competitive rate. Community banks should know what's what in terms of what an account is for and what the customer's price sensitivity is.

The above customer collects 2.47% in interest from their community bank. Assume this customer pays 35 bps of fees, and the net cost to the bank is 2.12%. The transfer price on this deposit relationship, assuming a four-year duration is 3.85%, driving net revenue of 1.73% (3.85%-2.12%). This would be a much more profitable relationship than just getting the $100,000 Money Market Account at a 10 bps spread (3.85%-3.75%) because that is what Capital One is paying. 

This math should drive funding strategies into the future. We can no longer rely on Rip Van Winkle customers accepting 250 bps less than branchless banks because the customer is not paying attention to what you are paying them in their price-sensitive accounts. It erodes trust, is easier to uncover, and easy to switch to a competitor. Our cost of funds should be managed by mix of funds. 

There is a reason why FDIC-insured banks lost $900 billion in deposits during the last Fed tightening and money market mutual funds gained $900 billion.

Few of my banking students knew this math. Shouldn't all of them know it? For my students, they know it now.

 

~ Jeff