Deposit interest expense in the era of open banking

Neil Stanley

Are bankers prepared for rising interest rates causing an accelerated fluidity of funds flow? Bankers who buy in to open banking will find that it could be antithetical to their objectives to hold the line on cost of funds as interest rates rise. There should be no surprise that, when we remove friction in the flow of funds, funds will flow toward high interest rates. Those who build the technology to attract and retain funds, may find that they have attracted and retained accounts — not funds.

Banks provide trusted commitments to the access of money. Open banking is designed to optimize depositor control of money. The more the industry creates convenience and reliability to manage depositor funds, the more depositors should value banking. So, from an industry perspective, open banking should be highly respected and valued by consumers.

We frequently think of deposit pricing and payments as separate dimensions of banking. I have heard it said that banking is the business of helping people who 1) Need money they don’t yet have; 2) Have money they don’t yet need; 3) Want payments made simply as they expect; and 4) Want accounting and documentation for all of the above. Today, we are poised to experience the intersection of the last three services.

Depositors are now armed and motivated to use the features and functions of open banking platforms designed to attract and retain bank accounts and transactions. The progress has been impressive, and it is reasonable to expect that high quality technology has created durable competitive advantages for many financial institutions to attract accounts and their associated ACH direct deposits and payment activity. Bravo! Bankers, you have won a privileged position as the bank of choice for many depositors. This positions you for material interchange and overdraft/NSF fees. You may have legitimately achieved the coveted status of “primary financial institution.”

If interest rates had remained benign at ultra-low levels, the health and well-being of your deposit strategy would have been easily confirmed. Properly priced funding would be delivered right along with substantial non-interest income. For many years now this has clearly been the ideal and prosperous scenario for banks fully embracing enhanced technology.

However, could a vulnerability lurk in the scenario? Have we unintentionally dismissed the potential impact of open banking on deposit price elasticity? Maintaining deposit balances may now be materially disconnected from maintaining the accounts and associated transactions. The explosion of APIs and open banking platforms raises a specter: Depositors can now effectively create their own sweep accounts to seize the newly available earnings power of their surplus balances. The days of depositors of all types leaving oversized balances in non-interest-bearing or ultra-low interest-bearing deposit accounts may be fleeting. Why would commercial, public and consumer depositors not leverage the money management tools that didn’t exist the last time overnight fed funds were at rates over 2.5 percent?

There is no historical evidence available to support or refute this hypothesis. We can only theorize that these forces that have been unleashed in the industry cannot be casually dismissed. We will not be able to successfully deny access to the technologies we have launched, sometimes with significant fanfare, because it now creates an ultra-competitive banking environment that the bank would prefer to avoid. There is no way to spin abandonment of our transfer technology successfully into a new public relations campaign. There is no going back.

Neither can any financial institutions opt out of the interest rate market. We are all along for this ride. The days of inconsequential interest rates making it futile to jockey for depositors’ attention are past, at least for a few years, while the Fed fights inflation. Depositors will soon recognize that putting a slight effort into the management of anything more than trivial deposit balances is well worth their efforts.

Isn’t it now reasonable to expect guidance and encouragement to take action to show up in community dialogue? What a perfect topic for the new communities not based on geography, but social media communities. Could we soon experience an environment where overnight Fed Funds are over 4 percent? When the public forums challenge everyone to seize the simple option of risk-less insured deposits that deliver worthwhile earnings? Maybe the new mantra will sound like this: “Friends don’t let friends leave money unemployed. Put your money to work today.”

Beyond technology, interest rates and the power of social media, could there be another contributing factor that makes this an even more serious threat? How will the depositor-friendly regulatory changes that eliminated prohibitions on interest for commercial Demand Deposit Accounts and withdrawal restrictions on savings accounts factor into this?

Collectively, the banking industry may need to recognize that it might have created a threat to cost of funds constraints as interest rates rise.  This can be expected to put tremendous pressure on financial institutions to compete for deposits while paying interest on a much greater portion of their deposits — and at rates of interest not observed in recent years.  

To succeed, bankers will have to think in ways that depart from the conventional approaches they have adopted since the Great Recession.  The best and brightest bankers will adopt new processes, products and sales platforms that help depositors put their money to work and make a profit for the bank in the process.  High-performing bankers will adopt non-conventional approaches that create value beyond mere interest rates when they:

  • Restrict pricing of common savings and standard term deposits
  • Display how offers stack up to competition in dollars
  • Limit reliance on promotional specials
  • Utilize a post-promotion offer to curtail the vicious cycle of promotion
  • Systematize and personalize exception pricing
  • Set qualifiers for opening and depositing to higher yielding savings
  • Refinance other financial institutions’ deposits profitably
  • Offer term deposits with daily mark-to-market redemption options

Neil Stanley is founder and CEO at The CorePoint.