Financial institution executives are preparing now, arming themselves with practical strategies to help succeed in a rising rate environment. After a long, slow thaw, the financial industry is finally entering the rising interest rate environment that has been expected for a while. After such a long period, many executives find themselves ill-prepared for what is to come and some are speculating about how consumer behavior will differ from past rising rate environments.
The last time consumers have seen this type of market was in 2003, according to Informa Financial Intelligence, who has tracked financial industry product interest rates for more than 35 years. Equipped with new technology and engagement channels, consumers may change how they will behave and what will trigger their financial decisions. Ease of online and mobile banking and consumers’ comfort with non-traditional financial services may make them dramatically more vulnerable to competitors’ offers.
How financial institutions respond to these changes and how well they execute on a strategy of differentiation, will determine what kind of margin impact they experience.
How quickly rates may rise is debatable. The Fed is forecasting 3-4 rate hikes in 2018 and 2019. Assuming 25 basis points each hike would put rates in the mid 3% range for a 12-month CD by the end of 2019.
What sort of consumer behavior can you expect in such an environment? Past assumptions on depositor behaviors are not likely to apply. Technology has lowered the effort a consumer must exert to change banks and new non-traditional digital players now compete for these same deposits.
When rates are decreasing, the consumers’ decision-making process is simple. Lock-in as quickly as possible, for as long as possible, before rates decline. With a rising rate environment, consumers want to take advantage of the future potential for rising rates. This can cause inaction as they wait for a better rate. This desire can also make customers susceptible to competitors’ promotional offers such as “bump-up,” or variable rate CD features, allowing for the potential of a higher rate in the future.
Since the beginning of 2018, Informa Financial Intelligence has reported an increase in promotional CD offers with “rising rate friendly features.” These features include bump rate CDs, which allow the customer to increase their rate if rates improve during the term. Bump rate CDs require a proactive action by the customer to increase the rate. The rate on variable CDs automatically adjust with market conditions and require no action from customers. Variable rate CDs can be tied to indexes such as the WSJ Prime Rate or Fed Fund Rate enabling the rate to increase with the index. In addition to CDs, we see liquid products such as money market accounts tied to indexes.
These features play on the consumer’s fear to lock into a rate while the market continues to rise. The ability to change a rate in the future may never be acted upon, but gives the customer the assurance that they can make a change should they choose. The variable rate CDs and indexed products build the rising rate environment into the account so the customer has the potential to improve their rate in the future.
Other offers reported by Informa include higher than market CD rates with “new money only” requirements and pairing of accounts and services to make products “sticky” (e.g., direct deposit required). These two tactics serve to attract new deposit growth while maintaining current relationships and holding down interest expense.
Over the last two years the Fed has raised its target rate by 150 basis points, and it plans on making the same increase over the next two years. But what will it take to excite the average saver? In other words, when will rates be high enough that financial institutions are at risk of losing balances to competitors?
Informa recently surveyed 2,500+ consumers across the country to collect information about their attitudes and perceptions around CDs. The basic premise of the survey was to try to figure out at what price point consumers would take notice of CDs. Based on the results of the survey, it is Informa’s opinion that the sleeping giant — the U.S. consumer — is going to wake up over the next two years.
Ninety-three percent of the respondents think that an APY of 5.00% or more would be good value for a 12-month CD. However, consumers are savvy, and currently more than half of the surveyed people would question the legitimacy of an offering above 3.00% APY for a 12-month CD under the current market conditions. The survey results also showed that about a third of the respondents would consider interest rates of at least 2.00% to be a good deal in today’s market.
So now that a few financial institutions are pushing interest rates above 2.00% APY, there are customers starting to take notice. Based on the survey, the tipping point for most consumers seems to be between 3.00% and 4.00% APY for a 12-month CD. Once the market moves into this range, we expect to see an increased demand for term accounts.
As rates continue to move higher over the next year, financial institutions need to be prepared for an awakening of the U.S. consumer. Financial institutions need to be prepared to protect their current deposit balances and have a well-formulated plan to capture new deposit balances is needed. At a minimum, the plan needs to encompass strategies for product offers, a robust marketing campaign, and financial education for consumers who have not seen a rising rate environment in quite some time.
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