Retain and Grow Deposit Market Share as Interest Rates Rise

For deposit-taking institutions, a rising-rate environment presents both a challenge and an opportunity - and deposit price optimisation provides a strong solution

Following an unprecedented 10 years of record-low interest rates and multiple false dawns regarding rate increases, the return of inflation has finally resulted in interest rate rises, with more to follow. This will provide some relief to savers, who are long-accustomed to negative real interest rates (and negative nominal rates in many European markets). 

For deposit-taking institutions, a rising-rate environment presents both a challenge and an opportunity. Until recently, deposit inflows have been relatively forthcoming without too much attention needing to be paid to price and ranking in the aggregator tables – but this is now changing.

The question of “Where do I want to be in the market rankings?” has been superseded by a slightly more complex one (and other questions besides):

  • Where would I like to be relative to where I think my competitors will be?
  • What if I am wrong about where my competitors will be?
  • If my competitors respond to base-rate rises by raising their savings rates, do I follow suit?  Or do I follow, but with a lag?  And if so, how long should that lag be?  

The answers to all these questions depend on your goals. A strategy of lagging your competitor’s rate rises following central bank rate movement may suit an organisation happy to shed some balances while looking to rebuild margins, but not an organisation focussed on maintaining or growing its market share. 

The Secret to a Successful Deposit Pricing Strategy

Irrespective of overall objectives, a targeted deposit pricing strategy can only succeed if it’s based on measurement and prediction. It’s almost impossible to set a strategy to achieve your goals if you have no way of quantifying the impact of what you are proposing. It’s also impossible to tell how closely you are tracking to your objectives unless you have structured way of tracking your objectives against what is actually happening in the market. Most institutions have finance departments that track performance at the portfolio level, though many tend to rely on static forecasts (using predictive analytics) rather than leveraging strategy-dependent forecasts (known as prescriptive analytics or optimisation).

A surprising number of organisations also look to achieve their deposit price optimisation objectives by turning the tap on (i.e. introducing a highly competitive product to the market) with only a rough idea of what will happen, and then turning the tap off again (withdrawing the product from the market or reducing the rate) when balance acquisition targets are met. 

Most deposit pricing managers admit that this is an inefficient way to achieve their objectives, but understandably need to balance this against the demands of a resource-intensive analytic project. The answer lies in an analytical framework that needs to be configured once and recalibrated thereafter in response to market shifts, but not rebuilt each time the analysis needs to be repeated. (Which is what often happens in the current market.) A movement in competitor rates definitely requires a repeat of the exercise to evaluate deposit strategy performance using refreshed assumptions – but it should not require an effort-intensive rebuild of the entire framework and all of its analytic components every time.

Keep Stress-Testing Your Assumptions

Which brings us to stress testing. Most analysts associate stress testing with the asset side of the balance sheet, or at least believe it is limited to assessing liquidity when it comes to liabilities. However, given the implications for profitability when even small movements in deposit strategy can make a large difference to the bottom line, stress testing should be employed regularly on any new strategy (whether introducing a new product or making a rate change to an existing one). We should be continually testing assumptions – especially those related to competitor rates, which we know may turn out to be incorrect.

There is one key additional challenge which remains: How do we make forecasts in a rate-rising environment when the last cycle of rate rises began in 2006?  

While there is no silver bullet for old data, the challenge underlines the importance of a framework that allows for periodic recalibration as new data becomes available. As mentioned, you should not need to rebuild every time you perform a strategy analysis – but it is critically important that you can quickly and easily leverage new data as it becomes available, especially at the beginning of the rate cycle when customer behaviours are evolving.

The last, most obvious challenge in developing a deposit pricing framework (irrespective of the macroeconomic environment) is complexity. Deposit pricing frameworks are necessarily more complex than loan pricing frameworks – payments don’t just flow in and out of financial institutions, they flow from back-book to front-book products, and between fixed-term and instant-access products as well. Because cannibalisation can have such a dramatic effect on profitability, we need to understand the price impacts on these internal flows, in addition to traditional balance acquisition and attrition. 

Modelling Cannibalisation Flows

The best-planned deposit pricing strategy can be undermined if these impacts are not taken into account. A new competitive product that absorbs flows from existing, more profitable products will cause some (and possibly all) of the benefits of any intended balance acquisition to be offset.

The good news is that cannibalisation flows can be (and have been) successfully modelled so that pricing strategies take these into account. However, the complexity this adds to the modelling and forecast process means that it is important to simplify this process by consolidating smaller, less important cross-product flows with larger ones. As with all challenges related to deposit pricing, this consolidation becomes even more critical when we add in the additional dynamic of a rate-rising environment.

Price optimisation is more vital than ever. Even in today’s climate of ever-changing rates and increased regulations, it’s possible to optimise your portfolio performance, forecast and preserve liquidity, and increase customer satisfaction. Improving your deposit account margins requires the power of advanced analytics and price-sensitivity modelling, which enables you to use relationship-based deposit pricing to reward profitable customers.

How FICO Can Help You Improve Deposit Pricing to Gain Market Share

Learn more about how FICO® Optimisation Solution for Deposit Pricing helps you maximize portfolio performance, accurately manage liquidity, and balance growth and profitability targets

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