To stay relevant, community banks must align their profit and risk goals with customer preferences—something the former retail behemoth didn’t do. Interest rate swaps are one strategy that can help achieve this.
By Rick Redmond and Tommy Warren, Vining Sparks
Existing for more than 125 years and surviving tremendous changes did not ensure the survival of Sears. The 20th-century retail icon’s bankruptcy filing at the end of last year reminds us what can happen when we fail to meet evolving consumer desires. There is a cautionary tale for community banks in the Sears story, too. Over time, Sears focused on itself, rather than on its customers. Its failure to adapt to changing customer preferences allowed Walmart, Amazon and others to replace it.
Current success does not guarantee continued relevance. In a late 2018 survey, Gartner forecast that 80 percent of financial institutions will be irrelevant or out of business by 2030. The largest banks are proving their relevance; the three largest grew from 20 percent of all U.S. banking deposits in 2007 to 32 percent at the end of 2017. The size and growth of the large banks should be of concern to all community bankers, as the days of competing only with local institutions, or relying on inertia or unaware customers are long gone. Consider these questions:
- How much of large banks’ deposit growth has come from community banks?
- How do I react to negative trends and transform my bank into one that not only survives but thrives?
- What value proposition do I offer my customers?
- Why would a prospective depositor do business with my bank?
There are several critical factors that must be in place to stay relevant with your customers. Let’s examine a few that closely parallel the problems that doomed Sears.
Competitive and efficient deposit pricing
We are all aware that core deposits are the “golden goose” of the banking industry. In the 2018 Bank Director Bank M&A Survey, sponsored by Crowe, 71 percent of dealmakers stated the potential target’s deposit base is highly important in making the decision to acquire. To be competitive in a global, internet-savvy economy, competitive deposit pricing must consider the changing banking landscape, the inherent value of core deposits and their importance to the survival of community banks.
Deposit pricing tends to be less disciplined than loan pricing but is equally or more important. Traditionally, bankers scanned the local newspaper or polled local competitors to determine deposit pricing. Now, however, large banks have become competitors and are winning the battle for deposits.
We almost never hear bankers mention the United States government as a competitor. If you offer CD rates lower than the rate paid on easily obtained Treasury securities, community banks must ask if depending on inertia or the unawareness of your customers is a viable business strategy. A bank manager would not invest in a security yielding less than a U.S. Treasury. So why would your customer purchase a bank CD that returns less than a U.S. Treasury they can obtain with a mouse click?
Have bankers, like Sears, become too internally focused, too concerned about controlling deposit betas and net interest margins at the risk of losing customers? We understand the desire to control funding costs, but this internal focus affects your deposit franchise and ability to survive. Are your valuable depositors serving as a source of large bank growth?
Efficient financial tools
The largest banks seemingly do an excellent job of providing products and services that resonate with their customers. They are generally able to overcome one of the great banking dilemmas: aligning bank desires with customer preferences.
Virtually all the large banks use interest rate swaps to solve this dilemma. Interest rate swaps allow them to provide products that are relevant to their customers while also meeting the bank’s profit and risk management needs. Swaps are simple, efficient, accepted by regulators and easier to understand than many products already on your balance sheet.
Managing interest rate risk on the backs of your customers or using less efficient methods will not provide the products needed to remain relevant. To thrive, community banks cannot follow Sears’ example, focusing on internal needs. They must listen and offer products customers want, delivered in the most efficient manner possible.
Your best competitors use the most efficient tools available to fund their assets, giving them a competitive advantage that allows them to attract your customers. Community banks must use these same tools to assure long-term survival and avoid becoming irrelevant.
It has been said the only constant in the business world is change. Transformation must be a priority for your community bank if you expect to thrive in a marketplace where your customer base is not protected by barriers that existed in the past. If you follow the Sears model of adjusting but not transforming, you may buy some time, but it will not be enough to assure long-term relevance.
Tommy Warren, CPA, is senior vice president at Vining Sparks Interest Rate Products, LLC
Rick Redmond, CMA, is president of Vining Sparks Interest Rate Products, LLC, and director of balance sheet strategies for Vining Sparks IBG