Sensing Seismic Change

Depositors are poised for interest rates to start rising soon

By Mark Haberland

The banking industry is finally starting to experience phenomena that indicate rising interest rates may, indeed, be on the horizon. How banks respond will have profound impact on the level of success they have when the Federal Open Market Committee finally makes its long-anticipated move to raise the fed funds rate. And it all starts with deposits.

Since the economic crisis, the banking industry as a whole has seen a continuous influx of non-maturity deposits into the system. Yet, second quarter was the first time the industry actually saw a reduction of deposits since the Wall Street financial crisis. Think of this in much the same way as how scientists predict earthquakes. This is the first seismic ripple that indicates something much bigger will occur in the near future with more widespread repercussions.

Depositors are starting to sense changes coming, and the expected migration of non-maturity deposits has begun. The ripple effects will be felt throughout the industry in terms of how banks position their loan portfolio, manage their funding base and price deposits. This expected migration brings to the forefront the importance of understanding the stability of your community bank’s deposit base.

Deposit studies have been the trendy choice of bankers in recent years to help support assumptions incorporated into the risk models (earnings at risk/value at risk/liquidity). But the biggest mistake banks can make with regards to understanding how their depositors will react to the impending rate increases is stopping at the documents provided with these studies. The data used to arrive at the studies’ results provide a window into the behavior patterns of your bank’s depositors. Separate the true relationships from the “rate chasers.” Identify the valuable core and know what it will take to keep their business while letting your unprofitable customers go—don’t be caught chasing after every dollar that may walk out your door.

Keep in mind, the banking landscape has changed dramatically since we last experienced a fed funds rate increase in 2006 (mobile banking, remote capture all make it easier for this generation of customers to move their money from bank to bank without ever setting foot inside one of your branches)!

Once you understand the stability of your community bank’s deposit base and what you will need to pay to maintain the levels you desire, this will set the stage for key discussions at your bank’s asset-liability committee in terms of how to position your bank’s balance sheet for the next rate cycle. Conventional wisdom says keep assets short in anticipation of rising rates. Yet, with the uncertainty of when that will occur and the speed at which rates will increase and customers’ desires for locking in low rates, banks often find themselves looking at fixed-rate lending options. By understanding how core your bank’s deposits are, you’re ahead of the game in terms of locking in some spread in today’s environment with quality credits, helping manage your bank’s net interest margin spread during the expected slow pace of fed fund increases.

A stable funding base also allows your community bank’s asset-liability committee to discuss the timing of locking in your bank’s own fixed-rate borrowing with the wholesale market. If you are going to lock in fixed-rate borrowings, it is helpful to do so at a time when you can offset the added expense with lending strategies as discussed above. These discussions are critical for asset-liability committee s to have today, as they help prepare for the impending events that will occur in response to the next Federal Open Market Committee meeting— whether or not it begins to raise rates. And all of these discussions start with a better understanding of your community bank’s deposit base.

Listen to the rumblings in the market. Your customers are sensing something is about to happen and are taking action. It’s time for you and your asset-liability committee to do the same, before it’s too late.

Mark A. Haberland is managing director at Darling Consulting Group, a bank consulting firm in Newburyport, Mass.