Bank Board Letter August 2015 : Page 2

is unsustainable for most institutions. That is why the results from the 2015 KPMG Community Banking Outlook Survey held few surprises. The study indicated that 46 percent of the banks that participated will increase their technology spending in the coming year. In addition, nearly 40 percent of the bank executives said they plan to make “significant” investments in IT related to online and mobile banking over the next one to three years. Where that money is invested will be the difference between perpetuating the current tactical approach and establishing a stra-tegic plan that can serve the institution for the next five to 10 years. Key indicators of a sustainable business model that will provide customers with the digital experience they demand include: • Solutions that offer a single code base for digital bank-ing and its many associated services, such as personal financial management; • Highly configurable products that do not require banks to contract with the supplier (and pay additional fees) each time a simple change in the disclaimer or branding scheme is required; and • Solutions that offer data analytics as a core feature and al-low the bank to “own” its data. Then, banks can accumulate, categorize and segment information about their digital banking customers and use that data to help customers with personalized information, products and services. How do you know if your bank is on the right track? The num-ber of online users at your bank should be growing by at least 3 percent annually. Your mobile users should number no less than 30 percent of the online total. If this is not the case, there could be a major bottleneck in user interface, intuitive design, customer awareness and even technology effectiveness. If you decide to make a change, first go to the C-suite. Executives must understand and be actively supportive of any effort related to transforming a bank’s digital banking landscape. Gaining that support may not be as hard as many suspect, given that the C-suite is in the best position to understand the positive impact a modern digital banking solution can have on the institution’s performance. Most banks must reevaluate their approaches to digital banking sooner rather than later. Rather than continuing to apply Band-Aids to the existing disparate channels and services already in place, they must step back and consider what their options are for building a five-to 10-year strategy that will address consumer digital demand, while delivering on the promise of lower fixed costs and better efficiency ra-tios. Business as usual will only assure that your bank is at a competitive disadvantage in the marketplace for the rest of its existence Ð which may be very short. Mark Vipond is CEO of D3 Banking, a company that reduces the cost and complexity of digital banking by providing a single code-based solution that can be accessed via laptop, smartphone or tablets. Its Data Driven Digital banking leverages a powerful analytics engine that allows financial institutions to personalize their product and service offerings for each unique customer. Learn more about the company at www.d3banking.com. Rising Rates: What Will you do When the time comes? By Thomas Farin I t’s Monday morning. Your deposit pricing committee is about to meet. You stick your head out the window and sur-vey competitor rates. Lo and behold, three of your major competitors have raised their money market rates by 25 basis points. After years of flat rates it has finally happened Ð we are finally in a rising-rate environment. Rising-rate environments do not come at us 200 bp at a time. They are more like water torture. Drip, here comes the first 25 bp. Drip, another 25 bp. Drip. Drip. Drip. There is a long-stand-ing belief in banking that rising-rate environments combined with flattening yield curves do damage to financial institutions’ net-interest margins. Data exist to back up this belief. But it is my contention that rising rates combined with flattening yield curves do not do the damage. Rather, it is all the lousy deposit pricing decisions the rising-rate environment triggers. Next moNth: A Retail twist on Branch Design Upgrading Your Core Processing Our “head out the window” banker’s pricing committee has three choices when confronted with the first 25 bp of competi-tor rate increases: (1) stand pat and lose deposits, (2) match the competitor rate increase and hold onto existing customers, or (3) trump the competitor rate increase and gain market share. If loan demand is accelerating, the committee is most likely to choose either (2) or (3). It is fashionable today to throw the words “pricing beta” into dis-cussions relating to changes in rates. A pricing beta is the percent-age of the change in market rates passed on to a customer. On page 3 is a graph of the beta for a money market account. The graph is a plot of a simple linear equation, “Y = a + bX.” “Y” is a plot of rate paid, “a” is the institution’s current offering rate (0.4 percent), “b” is the pricing beta (.75 or 75 percent) and “X” is the change in market rates (Treasuries, agencies, FHLB advances). For example, in the next rising-rate environment your com-petitors raise their money market deposit account rates by 75 percent of the change in market rates. Assume you decide to match them. As rates go up 1 percent, 2 percent, 3 percent and 4 percent, your MMDA rate moves from 0.4 percent to 1.15 percent, 1.90 percent, 2.65 percent and ends at 3.40 percent. Yikes! There goes your net interest margin. What if you did this instead: As soon as the first drip hap-pens, you roll out a new premium MMDA account and move

RISING RATES: WHAT WILL YOU DO WHEN THE TIME COMES?

Thomas Farin

It’s Monday morning. Your deposit pricing committee is about to meet. You stick your head out the window and survey competitor rates. Lo and behold, three of your major competitors have raised their money market rates by 25 basis points. After years of flat rates it has finally happened Ð we are finally in a rising-rate environment.

Rising-rate environments do not come at us 200 bp at a time. They are more like water torture. Drip, here comes the first 25 bp. Drip, another 25 bp. Drip. Drip. Drip. There is a long-standing belief in banking that rising-rate environments combined with flattening yield curves do damage to financial institutions’ net-interest margins. Data exist to back up this belief. But it is my contention that rising rates combined with flattening yield curves do not do the damage. Rather, it is all the lousy deposit pricing decisions the rising-rate environment triggers.

Our “head out the window” banker’s pricing committee has three choices when confronted with the first 25 bp of competitor rate increases: (1) stand pat and lose deposits, (2) match the competitor rate increase and hold onto existing customers, or (3) trump the competitor rate increase and gain market share. If loan demand is accelerating, the committee is most likely to choose either (2) or (3).

It is fashionable today to throw the words “pricing beta” into discussions relating to changes in rates. A pricing beta is the percentage of the change in market rates passed on to a customer. On page 3 is a graph of the beta for a money market account. The graph is a plot of a simple linear equation, “Y = a + bX.” “Y” is a plot of rate paid, “a” is the institution’s current offering rate (0.4 percent), “b” is the pricing beta (.75 or 75 percent) and “X” is the change in market rates (Treasuries, agencies, FHLB advances).

For example, in the next rising-rate environment your competitors raise their money market deposit account rates by 75 percent of the change in market rates. Assume you decide to match them. As rates go up 1 percent, 2 percent, 3 percent and 4 percent, your MMDA rate moves from 0.4 percent to 1.15 percent, 1.90 percent, 2.65 percent and ends at 3.40 percent. Yikes! There goes your net interest margin.

What if you did this instead: As soon as the first drip happens, you roll out a new premium MMDA account and move that account by 75 percent of the change. Meanwhile, you only move your existing MMDA account by 35 percent of the change.

Rate-sensitive customers will respond by moving their funds to the new service line. Nonrate-sensitive customers will stick with the existing service line. Assuming roughly half move, your cost of funds will move by 50 percent of the change in market rates. So after a 400 bp increase in market rates your cost of funds on MMDAs will be 100 bp lower (2.4 percent instead of 3.4 percent).

This form of deposit segmentation separates the rate-sensitive funds from nonrated-sensitive funds by forcing the customer to make a choice to effectively manage his or her money. You pay up for the rate-sensitive funds, but not as much for the nonrated-sensitive funds.

This general approach can be applied to nonmaturity deposits (such as savings, money market and premium checking) as well as CDs (using CD specials). It can be deployed in a defensive situation where you want to hold onto your existing funds (committee option 2 above) or in an offensive situation where you want to grow market share (option 3). But it is only going to happen if your pricing committee has thought through and agreed on the strategy before the first drip happens (proactive response). If the first drip happens before you have settled on the strategy and built the products you need, you are likely to pay up for everyone, rate sensitive or not (reactive response).

So here is what I suggest you do right now Ð before the first drip happens:

Break your deposit products into sectors; I suggest short-term CDs, long-term CDs, savings, money market and checking. Strategies should be developed at the sector level.

Review the products in each sector and ask yourself whether you have the products you need to implement a rising-rate segmentation strategy. If not, build the products so they are ready to deploy. Don’t fall into the trap of saying, “I already have a premium money market account, so I don’t need to build a new one.” That product has probably been in your chart of accounts for nearly a decade and is loaded with nonratesensitive customers your front line has put into the product over the last 10 years.

Develop a pricing strategy for the sector. The strategy will include any new products you will deploy in a rising rate environment, plus the rules you will follow in pricing the accounts in the sector.

For example, your pricing rule might be to price your regular money markets in the 25th percentile based on survey data and the premium account in the 65th percentile (defensive strategy) or 90th percentile (offensive strategy).

What if your existing money market account is currently priced in the 50th percentile? When rates start to rise, deploy your new product and price it in the 65th or 90th percentile. Hold the line on the existing product until its rate drops into the 25th percentile, then start raising rates enough to keep it there.

Of course, strategies can be much more sophisticated utilizing tier structures, geographic segmentation, stealth products, promotional rates, for example. But they all have the above approach as a starting point. If you need help thinking this through, give us a call.

Now smile. You are ready for that first drip to happen and you are going to be a hero as a result of saving a ton of money as rates head up.

Thomas Farin is chairman of the board of Farin & Associates Inc. He can be contacted at 608-661-4219 or tfarin@farin.com.

Read the full article at http://omagdigital.com/article/RISING+RATES%3A+WHAT+WILL+YOU+DO+WHEN+THE+TIME+COMES%3F/2243026/269172/article.html.

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