Tuesday, May 22, 2012

Who's Minding Your Deposits?

Bankers consistently identify deposit growth as a principle driver of their future success. At the same time, experience shows that many banks still employ a relatively antiquated approach to manage their deposit gathering efforts. They generally take a "if it isn't broke, don't fix it" approach and continue with the same strategies that have served them well in the past.

Well, like it or not, the financial landscape has changed dramatically. Now more than ever, banks must adopt more proactive deposit management methods, acknowledging that it is vitally important to incorporate deposit structure risk into the institution's long-term risk management strategies. The truth is that a bank cannot effectively manage its risks if it is not evaluating all available options in its efforts to properly manage and price its deposit-products.

Virtually every bank has a designated risk management officer who is charged with developing overall risk management policies and procedures and ensuring that they are consistently applied across branches and business lines. Many of these banks, however, lack the resources to focus directly on coordinating the multiple aspects of deposit management.

Banks should, therefore, consider appointing a "Deposit Strategy Officer," a person whose responsibilities would include: diversifying funding sources; knowing the local market; educating management and directors; understanding the environment and alternative funding sources outside the local market; and actively fostering an appreciation of the liability side of the balance sheet among those in charge of the asset side.

There are several reasons why now is the time to consider appointing a Deposit Strategy Officer.

The World is Smaller

The days when community banks could rely on bricks and mortar for adequate deposits are a thing of the past. Banking is no longer a local activity. The proliferation of the internet and financial publications has given both retail and institutional customers access to banks around the country. Customers can compare rates and maturities, get advice and execute transactions from the comfort of their own homes or offices any hour of the day or night. In addition, competition has widened. Deregulation has enabled financial services providers to offer competitive deposit products. As a result, a community bank in Little Rock has to compete with the mega-corporations as well as with banks in, for example, Maine and California for the customer whose home or business is down the block.

To successfully compete in this expanded market, every bank needs a comprehensive deposit growth strategy. This strategy should outline not only how the institution is going to operate locally, but also how it can tap markets beyond its city limits when such action is warranted.

All Deposits Are Not the Same

When changes in asset composition necessitate changes in funding strategy, banks need to know how and where to get funds most cost-effectively. Pricing and available maturities vary from market to market. It is imperative that a point person within the bank be continually informed as to the cost structure and availability of multiple lines of funding. If a bank needs one-year money, an ad in the local paper or an in-branch campaign may do the trick. However, the bank may have to implement a more diverse strategy to raise the deposits that are often needed to match the longer assets on the balance sheet. A bank that limits its deposit gathering to local markets may be exposing itself to potential mismatch.

It is also important to consider not just the rate, but also the efficiency of access. Advertising a special rate on a CD or money market fund may raise the needed deposits, but the bank has very little control over the amount and timing of these deposits. In addition, the cost of funds will also include not only the advertised interest rate, but also the advertising fees and the staff needed to field calls and potentially process thousands of relatively small deposit transactions.

Alternative funding sources such as wholesale products, for example, provide low-cost, on-demand access to deposits with considerable operational efficiencies. Building, maintaining, staffing and supporting brick and mortar branches carry significant ongoing costs. Wholesale funding, on the other hand, operates on a "pay-as-you-go" basis. You can turn the lines on and off according to your needs and you only pay for it when you need it.

Risk and Deposit Management Are Intertwined

In today's volatile interest rate environment, mismatched assets and liabilities can represent a major risk. To manage this risk, banks need policies and procedures that make the liability matching structure more efficient.

Current risk management policies take rigorous steps to minimize default risk, but often do very little to protect against the cost-of-funds risk in a rising interest rate environment. Just consider: Whenever the return on a loan portfolio is repricing, it is critical that it align with the repricing on the liability side-i.e., similar direction and similar frequency. The bottom line cost of so-called cheap deposits like interest-bearing checking accounts and money market deposits can increase dramatically if they are tied to indices that are overly sensitive in an unfavorable interest rate environment. Therefore, it would appear to be in a bank's best interests to balance those deposits with a ladder of longer term deposits to protect against a rise in interest rates.

This could, however, prove to be a challenge for banks that focus primarily on their local geographical areas and traditional customer base. The flight to quality triggered by the economic meltdown and the higher FDIC limit has resulted in a deposit spike for most banks. While this is certainly good news, there may be an inherent problem. This flight to quality is also, in most cases, a flight to liquidity. Most of these deposits are going into savings accounts, money market funds or CDs of one-year or less.

In times like these when the public is thinking short-term, the Deposit Strategy Officer would be charged with going beyond local markets and finding alternative sources of longer-term funds.

The Case for Deposit Strategy Management

Banks continually talk about the importance of deposit growth, but generally do not take the steps necessary to address deposit-gathering in a systematic and consistent fashion. A strong deposit strategy management will help the bank more efficiently generate cost savings that will translate into increased profitability.

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