The Price of Everything

Banks across the country are waking up to the importance of deposits and creating a new position: Chief Deposit Officer.

From today’s Wall Street Journal ($): Banks’ Cry: Give Us Your Cash

Total deposits as a percentage of assets on hand at the end of September at the country’s more than 8,700 insured banks and thrifts reached the lowest level since the Federal Deposit Insurance Corp. was established in 1933. At the same time, the banking industry’s net interest margin — the difference between the average rate banks earned on their interest-bearing investments and the rate they paid to fund those investments — dropped to a 17-year low in the third quarter of 2006.

So, in the scramble to sign up new customers for savings, checking and other accounts, the industry has decided it needs a new specialist: the chief deposit officer.

Banks are smart to shift focus to deposits - they are the engine of bank profits. The graph below shows that Wall Street rewards higher deposit banks with a larger price to book.

The takeaway from this graph is to focus more on deposits. But this doesn’t mean banks should avoid wholesale funding. In fact, wholesale funding can protect solid deposit strategies. It allows banks to avoid cannibalizing their current deposit base.

Is the Chief Deposit Officer a smart idea or a fad (like Chief Reengineering Officer or Chief Customer Experience Officer)?

I think this is idea is a keeper. Banks need an executive to focus on the various approaches to deposit pricing. Optimized deposit pricing is coming. Large changes in profitability are coming. Will your bank be ready?

Hat tip: Steve Janaszak

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Bankervision analyzes customer feedback about overall bank satisfaction and comes up with some interesting clues. Of particular interest:

• Customers care most about good rates - People who rate their bank well also rate the prices well.

I think James’ analysis is correct, but I draw different conclusions. In experience with more extensive data, some customers (and deposit products) are more rate-sensitive than others, but many customers barely care about rate. How can the data sets be resolved?

1. Customers may care most about service, but falsely remember a poor rate when surveyed. This may be because interest rates are the most easily quantified component of customer value. I suspect a low correlation between rate satisfaction (and perceived rates) and actual interest rates.
2. Poor rates may be a problem customers live with (much like certain cancers are often discovered after people die of old age). The majority of reviews are from current customers, so they are describing issues they would like changed, but not enough to switch for.
3. Customers lie. They (correctly) view rates as easily modified and service, convenience as nearly immutable. Customers get better service quickly only by switching banks and better rates by convincing bankers to give better rates. Banks can only change service and convenience levels through glacial change.

Bank customers hope that if they say they care most about rate, all banks will give better rates. In reality, customers are best served in the long term by matching prices to true rate sensitivity. This rewards banks which have dropped their depositors’ rate sensitivity (through convenience, service, etc.). Ultimately, customers that care about rates get good rates. But everyone receives maximized value.

No matter what your customers’ price sensitivity, it’s important to correctly measure and then build into correct equations for total long-term profitability. If bank customers are very price-sensitive, your prices should approach the wholesale alternative cost of funds. If customers don’t care, rates should approach the “embarrassment” rate.

Update: Financial services marketing guru Ron Shevlin advances the argument that bank customers are only inadvertently misleading (in comments).

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Banking used to be a pretty simple game. Take in deposits from some customers and loan the same money to other customers. And earn your profit on the difference.

The last 30 years have changed the game. Deposit gathering is now divorced from smart investing. If your deposits aren’t enough to fund your loans and investment portfolio, you can make up the shortfall on the wholesale market.

Why is this such a big deal?

Extra investments let the bank increase its risk and returns. If you are following solid risk management strategies (diversification and careful analysis of the risks in your portfolio), the bank is far safer than during the old days. The extra boost in risk lets the bank make more money, but still prevent meltdowns.

More important from a pricing perspective, balance level no longer must be a goal in itself. The deposit pricing committee can focus on optimal rates (high enough to keep balances around, low enough to increase profit margin) and let the treasurer ensure the bank is fully funded.

The bank doesn’t have to pay up for local balances. Of course, the rest comes at higher, wholesale rates. But the bank can keep its total costs lower than if the bank raised all the deposits locally.

The FDIC Banking Review comes through again. The Liability Structure of FDIC-Insured Institutions: Changes and Implications:

The study gives terrific information about the wholesale market. It outlines the major funding strategies and shows how important wholesale funds have become.

I would only disagree with the authors on the impact of the structural changes. I think the increased reliance on wholesale funds has a lot more to do with rate strategy than risk.

Hat tip: Steve Janaszak

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The current received wisdom of the internet? The Long Tail. Amazon and Ebay are providing value because they offer enormous choice. True enough, but only when it’s easy for customers to find what they need.

My local diner - the choices are tasty, but it’s overwhelming:

Read more »

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Fair Isaacs has seen it all.  FICO’s James Taylor takes off from a recent piece from TowerGroup’s Kathleen Khirallah by placing it in a larger context. 

The key element to get started is that Banks need more finely grained segmentation for their pricing. Most of them already do a great job of segmentation for risk, credit line management and so on but they lack this approach in pricing. They don’t have a comprehensive pricing strategy that reflects the sensitivities and desires of customers.

While traditional segmentation works pretty well for loans (customers expect individualized pricing), this can be tricky in deposits - and banks should tread carefully.  Read more »

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BTN reports a new service for bank customers: placing shredders in the branch.

What’s the connection?

Banks sell trust and security.  Customers want to buy peace of mind - and one of their deepest financial fears is identity theft.

Leave aside the profit implications of offering this product for fee.  The service deepens the relationship with your customer exactly along your key branding as a bank. 

Shredding is similar to placing a coin counter in your lobby.  Take care of your customers’ financial headaches and they will stay loyal. 

Of course, only offer services that enhance your key value proposition - no lottery tickets, hedge funds, or payday loans, please.

Bankers: You can lower your optimal rates by changing rate sensitivities.  Deepen your bonds with the customer and use your retail presence to your advantage.

Update: Shredding is spreading to banks across the country.  From American Banker ($) (hat tip: John McCaffery):

National Penn Bank has had such good attendance at its shredding days that it is considering handing out coupons for special bank offers at next year’s events, said Linda C. Hill, director of retail marketing for the subsidiary of the $5.2 billion-asset National Penn Bancshares Inc. in Boyertown, Pa.

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From the NYT, Diner Beware: Turisti Pay More in Roman Restaurants

It might be an extra 30 cents for an espresso, or a $5 tithe tacked onto a bottle of wine. It may even mean the substitution of lower grade ingredients. But the practice of charging tourists more does exist and is committed daily, even hourly. If executed properly, the turista will be none the wiser.

“You think you are being taken care of,” said Christian Boyle, a Londoner who has spent some months in Rome. Soon after arriving, she and some friends displayed fatal naïveté, when they were not sure what to order at a restaurant just off the Piazza del Popolo. “We couldn’t decide,’’ she said, “so the waiter said he would bring us some things to try.’’

“One thing kept arriving after another,” she said. Things were fine until “he charged us full price for all these little dishes that we thought we were just trying.”

People hate getting cheated.  Evolutionary psychologist Leda Cosmides built pretty cool experiments to demonstrate how good we are at finding cheaters.  Turns out, the human brain specifically evolved the ability to detect cheaters.

Which brings us to price gouging.

Read more »

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Zopa is a shot across the bow of traditional banking, much like Commerce Bank.  The effects will take years to play out, but the best banks will take the opportunity to hone their competitive edge right now.

Zopa is a classic blue ocean strategy.  It will likely create brand new customers in areas like personal loans rather than pull them from banks.  But zopa may also hit banks in their sweet spot of low-cost deposits.

Banks should not compete directly against zopa on price.  Banks have a different cost structure - and a different product.  But they should think about lessons from zopa - as well as areas where traditional banks can excel. Read more »

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We saw in part one that peer-to-peer banking has a lot going for it.  But there are some strong negatives too. Read more »

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A few months ago, a venture capitalist asked my opinion about Zopa.com - a new financial startup. I told them I thought they were not much of a threat to banks. The VC went on to fund the company, which goes to show how little I know. Read more »

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