By Zafin Editorial In Collaboration with Nomis

The days of ultra-low interest rates in the United States are numbered and when they rise, banks can expect retail deposits to go into flux. But how depositors will behave no longer needs to be a mystery: customer analytics and sophisticated execution can keep banks’ powder dry so they can go on to earn another day.


Rising U.S. interest rates: It’s a matter of when, not if

Fed Chairwoman Janet Yellen has indicated that 2015 is the year for a hike, but at the September 17 committee meeting held rates steady, citing market concerns. And while there is dissension among the Fed ranks on the timing (but not direction) of a move, gradual future rate increase (about one percentage point per year) is the broad message.

The market response has been mixed but a consensus of “before-year-end” has emerged. The Financial Times reports that despite a mediocre market outlook, two-thirds of the 46 global economists polled expect the Fed to hike rates at its December 2015 meeting. See Figure 1 for their summary.


Figure 1: When bank economists expect the Fed to hike rates

Source: The Financial Times

While global markets (and U.S. trade) will influence other central bank policies, they will, of course, follow their own timetables for rate increases based on market and economic conditions.


The cost and risk of a “Too little, too late” response to rate increases

Whatever the timing for a Fed rate increase, the FT suggests “the received wisdom in the banking sector is that higher rates are great news. U.S. banks with their domestic focus can push a Federal Reserve rate rise on to many of their borrowers pretty quickly. They can also try to delay passing the benefit on to savers as long as possible.”

But will the “great news” be spread evenly among banks? We think not. There are several key factors that will challenge banks’ abilities to develop a timely and robust response to rising interest rates. They will need to strike a balance between deposit stability, regulatory compliance, bank profitability, and customer retention. These factors are discussed below.

Predicting customer behaviour. Predicting how customers will behave in the face of proliferating investment opportunities first requires an understanding of a bank’s customer base. Through analysis of short- and longer-term transaction behaviour across customer relationships, a bank can segment customers, determine price elasticity, promote price optimization and develop an overall rate strategy that focuses on encouraging “best” (most profitable) customers to remain loyal.

Liquidity and conduct risk regulations affecting deposits. By delineating between “core,” longer-term deposits and more volatile, short-term “non-core” ones, Basel III’s Liquidity Coverage and Net Stable Funding Ratios determine how deposits within a bank’s liquidity structure are valued.

Retail deposits are assigned lower coverage requirements and are therefore more valuable when developing a funding/liquidity strategy. By tracking and analyzing customer deposits – and deploying a responsive rate management mechanism (discussed later) – banks can ensure that regulatory requirements for transparency are met while the “best” customers are incentivized to stay. And minimizing the number of touches required to execute that strategy can limit errors of omission or commission along the way.

Competitive forces. To be sure, while a particular bank is developing its “rising rates” strategy, so will all the others. But not all banks can and will energize equally to meet the challenge. And many banks are starting at a deficit, having not adequately invested in the past in automated technology for retail deposit pricing.

Typically, they depend on a pricing mechanism that is:

  • Product-centric: ignoring the broader value of a multi-product customer relationship that might exist;
  • Data-insensitive: Limited, if any, automated analysis of customer data, formal customer segmentation at a granular level, or use of available market data;
  • Infrequent: Committee-based and spreadsheet-driven efforts that are held annually; and
  • Opaque: Difficult to provide needed transparency to customers or regulators.

These rigid, arcane processes won’t stand up during periods of rising rates. As Chris Nichols writes in his CenterState Bank blog: “Rising rates will once again shift depositors’ attention to structures, rates, and associated fees … If your bank only reviews fees once a year, you could find yourself already suffering an outflow of customers by the time you get around to adjusting your fees or offering a new structure.”


The power of customer analytics and pricing optimization

Nomis is enabling both global and smaller banks to analyze and predict customer behaviour as interest rates and other macro factors change, and to develop optimized pricing to achieve their goals irrespective of market conditions. Specifically for deposits, they help answer the questions: “What will happen to our customers’ deposits when rates start to rise and what targeted rate strategy will I need to achieve my growth, profitability and liquidity targets as markets and competitors move?”

Banks have traditionally attempted to solve this challenge by looking at very coarse buckets across product, regions, terms and tiers. While still important, these categories do not, by themselves, get to the heart of why customers behave the way they do under different scenarios. By leveraging billions of transactional signals, real-world test-and-learn information and third party data characterizing a customer and household’s life stage and lifetime potential, Nomis has developed a four-category, 25 micro-segment framework for understanding and predicting customer behaviours. They call it their “Behavioral Segmentation Matrix”. See Figure 2.


Figure 2: Nomis’ Behavioral Segmentation Matrix for retail deposits (click to expand)

Source: Nomis

While the sweet spot appears to be the “Keepers”, who are sticky and rate-insensitive, it’s not about ranking favourites. Rather, it’s about using those insights to develop targeted plans for each segment to achieve a desirable outcome for the bank. Each segment will demand a different response – the more rate sensitive, the quicker the bank will need to sweeten the offering, especially for more fickle clients like “Chasers” that are also high value. Being more relationship-focused, “Seekers” should see an investment in building trust and understanding (and responding to) their specific needs. Perhaps this takes the form of a targeted promotion that offers a client something he wants: Baseball tickets or a break on foreign exchange rates for his regular travel, for keeping a minimum balance.

The next step after understanding customer behaviour is optimizing pricing and offers for each Product, Market and Customer segment. And as markets, competitors and customer behaviour become more dynamic, pricing needs to keep pace. “One size fits all” and infrequently changing pricing can lead to a “one size fits none” outcome. Forward-thinking banks are leveraging next-generation pricing optimization platforms to develop smarter and more agile pricing processes.

A framework for automated pricing governance and execution

“Strategy without execution is the slowest route to victory,” said Sun Tzu and he could have easily been referring to pricing. Building upon this analytical “deep dive” into customer segmentation and dynamic price optimization capabilities, banks should seek a fully automated approach to execute customer-tailored rate strategies. This level of sophistication requires a rules-based engine in place that can provide differentiated pricing to clients and be nimble enough to pivot as conditions change.

Figure 3: How deposit pricing optimization and execution capabilities work together


The good news is it’s not as hard as it sounds. With a dynamic price optimization platform, such as Nomis, and a flexible pricing execution engine, such as Zafin, you can create and automate segment-specific rate strategies, offer limited-time promotions and more. So whether you’re targeting the Chasers, Seekers, Spectators, or Keepers, you have the right tools to do the job.

Here are a few examples of segment-specific strategies you can employ as rates begin to rise.

Chasers. Proactively engage this group with a preferred rate campaign, with a bank-by-bank rate comparison tool and specific conditions tied to the promotion, such as minimum balance and term requirements.

Seekers. Promote the benefits of the customer’s relationship with the bank and why you’re different, with an offer to deepen the relationship further with additional products. Extend an invitation to a customer appreciation event or some other form of reward.

Spectators. Create a graduated rate structure to reinforce the desire for no commitments, but incentivize both an initial deposit and additional deposits over time. For example, you could offer an interest rate of 1% for the first three months with a minimum $1,000 initial deposit, with the option to increase the rate to 1.25% for the next six months with a minimum $3,000 total deposit.

Keepers. Use the rising interest rates to engage this group with a complimentary assessment of their deposits and overall product portfolio. Send a personalized thank-you note showing your appreciation for their loyalty. Consider a bonus interest rate or some other reward as part of an exclusive referral program for new deposits from family, friends and colleagues.


Key takeaways

Whether it’s three months from now or nine, the U.S. Federal Reserve and other central banks will begin the slow, steady tightening of their interest rate policies. If history is any guide, rate increases will usher in a period of uncertainty for banks and their deposit bases.

By approaching the problem head-on with an informed plan to segment clients and execute differential strategies for them, banks can improve their chances of retaining customers, increasing balances, deepening deposit relationships and enhancing profitability.


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