The Role of Branch Networks and Information Scale in the Coming Deposit Re-price Cycle


“The customer who likes to visit a branch is less price sensitive than a customer whose relationship is online-only. Banks haven’t fully understood that if I have a branch in this neighborhood, it reduces price sensitivity[1].” Frank Rohde, CEO of Nomis Solutions

Over the next three years, the key driver of bank earnings will be the rate sensitivity of deposits. Applying the 50% re-pricing beta (i.e. ratio of rate-increase on deposits vs. rate-increase on short-term wholesale funds) of the last up-rate cycle to the $10tn of deposits held by US commercial banks and the 2.8% increase in 6-month Libor indicated by the forward markets through mid-2017 suggests deposit franchises will add $100bn to after-tax earnings; this compares with total 2013 earnings for US commercial banks of $144bn.

We acknowledge the benefit in this up-rate cycle may be less with the customary shift to high-yielding certificates more pronounced (and reversing a trend that has caused non-interest bearing deposits to rise to 25% of total deposits from 17% in 2008) given lower search-and-switch costs for depositors: services like create have increased pricing transparency and online-only bank platforms (now accounting for 6% of deposits) have empowered consumers to “rate-surf” by shifting balances between banks.

However, the bigger issue is likely to be variations in rate-sensitivity across banks: in the last up-rate cycle, the best-performing quartile of the to-50 US banks had a re-pricing beta (i.e. the ratio of change in rate-paid on deposits to change in short-term wholesale funding rates) of 33% vs. 78% for the worst-performing. The hi-lo range of 45% across banks compares with JPM’s adjustment of 5% to its deposit re-pricing beta to account for secular change in customer behavior across time; specifically, JPM uses a go-forward beta of 50% vs. the 45% of the last up-rate cycle.

As rates begin to rise and the risk of deposit outflows increase, the challenge for banks will be attracting and retaining balances from rate-sensitive customers while not re-pricing the entire book; we see the trade-off between balance-formation and margin-enhancement as stimulating more sophisticated and finely-segmented deposit pricing than in the past. Winners will execute pricing strategy at the level of individual customers in a massive extension to data-enabled marketing of the “desk drawer” policies of past up-rate cycles (where branch officers would extend a special rate-offer to high-value customers threatening attrition).

Key success factors in data-enabled deposit marketing and pricing will be information-scale and return-to-skill: the scale to capture large amounts of data on customer interactions so as to develop statistically reliable insight into behavior, and the skill to monetize these behavioral insights across large numbers of customers. Beyond their favorable impact on customer loyalty, branches play an important role in data-gathering since they remain a key point-of-interaction for large swathes of customers[2], and advantaged pricing for these customers gives a branch-bank more flexibility in competing on price with online platforms for less branch-engaged customers.

This thesis rests on banks digitizing in-branch interactions, and we see this (along with reducing the need for tellers and improving customer convenience) as an important driver of large-bank moves to automate in-branch experience through, for example, touchscreen ATMs and iPad-equipped tellers. We expect this will evolve to support phone-enabled interaction of customers with “smart” physical infrastructure over wireless channels such as Bluetooth and NFC. Of course, this is part of a broader move towards the digital engagement of customers at retail outlets to integrate transaction-processing (whether payment at a retail store or deposit-posting at a bank branch) into a digital channel that improves the customer experience and supports data-enabled marketing and messaging.

We believe the large chain-banks (so BAC, WFC, and JPM) will be increasingly advantaged with the shift to digitization of in-branch processes and data-enabled customer management because of increasing returns to scale (both processing and information) and to skill:

  • Processing Scale: The payoff for making the fixed-cost investment in digital platforms is lower variable costs-to-serve; JPM, for example, reports that the variable cost of a remote deposit (where a user scans a check, often using a smartphone, and transmits the scanned image or ACH-data to a bank for posting) is 3 cents vs. 60 cents for a teller-assisted transaction and BAC that ~10% of deposits are now remote (vs. 6% in the year-ago quarter and zero in 2012Q1). This swapping of fixed-for-variable costs lifts the return to scale.
  • Information Scale: Large chain-banks can cast a broader net to capture changes and nuances in customer behavior as they emerge (in one region ahead of another, for example) and have larger sample sizes that can increase statistical reliability of data-driven inferences.
  • Research Scale (or return-to-skill): Furthermore, the large chain banks can invest more in test-and-learn research because the findings can be deployed across large customer bases.

Given these structural advantages will enable more precise deposit re-pricing, we expect the chain-banks to show margin outperformance relative to the industry, and note that this view is endorsed by specialists with access to in-house data. In a December 2011 study[3], for example, consultant PwC concluded that “the success of the largest banks in maintaining low volatility, low-cost deposits indicates that national banking capabilities (leading products and branch coverage) are most advantageous”.

Furthermore, there is already evidence that the national branch networks of the chain-banks confer economic advantage. For example, WFC, BAC, and JPM have a disproportionate share of deposits (with an “impact” ratio of deposit-share to branch-share of over 2x vs. an industry-average, adjusted to exclude the “big-3” of 0.6x – see Exhibit) and hence advantaged leverage of fixed-costs.

  • We use “core” deposits in the analysis (i.e. excluding brokered deposits and time deposits over $250k), and note that the ratio of core-to-total deposits is higher (at 96%, 92%, and 98% for WFC, BAC, and JPM respectively) than the adjusted industry average of 87%.
  • Despite the use of core deposits, there may be a residual distortion from corporate franchises so that, for example, the 5.5x ratio for C is likely not a fair measure of branch efficacy. We exclude C from the analysis along with banks, such as COF and DFS, where branch footprint is not representative of the deposit franchise because of large online-only platforms.

Finally, we expect a wave of innovation in deposit products from the large chain-banks as they implement test-and-learn strategies around deposit pricing. As described by Elting Morison in “Gunfire at Sea: A Case Study in Innovation[4]”, this is a frequent consequence of platform innovations improving process-control and feedback, was a feature of the credit card industry in the mid-to-late 1990s (where COF’s information-based strategy led to innovations such as teaser-rates and zero-balance transfers), and is nascent in the deposit business.

  • For example, Russia’s largest private bank, Alfa Bank, has introduced a “healthy is the new wealthy” savings account[5] which ties the rate paid to a customer’s physical activity (tracked through apps such as RunKeeper, Jawbon, and Fitbit). This, in turn, drives increased mobile and online usage (and hence customer engagement with the Alfa brand and data) because customers are curious to see the impact of their latest work-out on their balances and rates.

Please see our published research for the full note and tables.




[4] At JPM, for example, over 55% of commercial customers use a branch each quarter. And, at WFC, 85% of new products are sold through branches even while 85% of routine transactions are conducted over digital channels.


Print Friendly, PDF & Email