Quality deposits and a clearer digital picture

Deposits have turned the corner. The updated BAI State of U.S. Deposits flags cautious improvement for consumer and small-business deposits in 2025. But margins will still be tight. Expect average bank rates holding well above 2% through the end of next year even with the Fed Funds target slowly coming down.

Quality matters. Financial institutions aren’t as willing to settle for single-service, high-balance nonprimary customers as in the recent past. Instead, banks and credit unions are getting back to the business of attracting primary customers for the long haul.

The digital investment dilemma. Digitally sourced deposits, from a total-portfolio perspective and not just originations, hover at only a 10% slice of the portfolio.

TRANSCRIPT

Even in 2025, a strictly digital-first approach to opening and growing deposit accounts does not guarantee a role as a customer’s primary bank. With cautious deposit optimism shaping 2025, what does it take to attract and lock in quality deposits?

This is the BAI Banking Strategies podcast. I’m Rachel Koning Beals, senior editor with BAI, joined by two of our research leaders to discuss what’s driving deposit behavior as 2025 looms.

Isio Nelson and Tom Hoscheidt, both managing directors at BAI and working closely with our Research Intelligence, join the podcast to continue the discussion launched during a recent State of U.S. Deposits webinar.

Their insight is informed by BAI’s latest consumer and small business weekly deposit data and our team of industry analysts. For a look at the data and charts supporting this conversation, you can replay the State of Deposits webinar at bai.org under the Banking Strategies webinar dropdown.

Now… Isio, Tom, let’s go deeper on deposits…

Rachel Koning Beals: Tom, as we check back in on the State of U.S. Deposits and get ready for 2025, what can we share about deposit health overall?

Tom Hoscheidt: The state of deposit health is definitely improving. We’ve turned the corner in terms of deposit balance growth. We’ve been headed lower since the end of the pandemic. And we’ve seen in our numbers that there’s a turnaround. We’re starting to head into positive territory, and it looks like next year we’ll be in positive territory [on consumer deposits].

Koning Beals: Isio, you’ve really stressed how important quality deposit growth is. What determines quality in our current environment?

Isio Nelson: There are a couple of different definitions of quality that the banks look for. Obviously, one is tenure, or how long the consumer or small business stays with the institution, that they’re not just renting some interest rates for a little while. Another piece is the size of the deposits and the number of accounts that they have. Primacy is another good metric that’s used. And primacy is really where that ACH account goes from the check and then where there’s an opportunity for payments that are coming out of that account, that the institution is to be able to look at it as a primary account. So, a lot of different definitions of quality, but primarily what [banks and credit unions] don’t want to do is just buy somebody’s deposit for a limited amount of time and not have a broad relationship.

Hoscheidt: The only thing I’d add to that is that, following the Silicon Valley Bank situation, there were some concerns about liquidity and a lot of the super regional, and some of the regional, banks were pretty aggressive in terms of their rates. And when they were that aggressive, they did attract a lot of deposits, but bouncing back off what Isio said, they weren’t necessarily quality deposits. They were just sort of a single-service relationship, if you will. And so what [banks and credit unions] are trying to pivot to now is sort of away from attracting the single-service, high-balance nonprimary customers to getting back to the business of attracting the primary customers, building that relationship, and then as you said, seeing a longer-term relationship as a result.

Koning Beals: You looked a little deeper, Isio, into digital and non-digital deposit significance. What’s driving that?

Nelson: So one of the things that we’ve been asked by the industry is [for research support] because they’ve been spending a lot of dollars on investing in digital. They know that customers have a big desire for digital and so [banks and credit unions wonder], what does that mean as far as to how they used to do business versus now? And is it driving some quality metrics that we just talked about?

There are a couple of things we’ve seen, just to quote some of the numbers we talked about in the U.S. State of Deposits. [First], as for checking originations back in early 2023, about 30% of [deposit] originations were coming from digital versus more traditional, like branch and call center. That’s up to about 38% now, as of the fourth quarter here. So, we are seeing that trend coming back up. A lot of that was the banks pulled back for certain reasons, like fraud and just user experience. Then consumers also get more comfortable with it as we start to click down into [the data].

The other thing, though, to understand is that it’s not just one-for-one. When you originate a digital account, numbers can go as high as about one-third of those accounts are going to go ahead and attrite within the first 12 months. And what happens is [FIs] need to make sure that you’re either filling the top of the funnel or you’re doing things to keep those customers … engaged.

We also saw, as we look at digital from a total-portfolio perspective and not just new originations, it’s still a fairly small percentage of the total portfolio. Only about 10.5% of the portfolio is digitally originated across the industry that we look at, which leaves about 86.5% non-digital. Now those [deposits] were accumulated over years. They were customers that have been there for a long time. So, to be able to shift that look is difficult, especially if [customers] are coming on and leaving quickly.

The other piece that we started to note as we went through the standard-use deposits was those digital account holders only hold about $19,000 in deposit balances [on average], while the non-digital are holding about $33,000… So, the difference, or type of quality, is the size. [FIs] might say, Okay, well, that’s because there are Millennials that are opening digitally. So we start looking at that. We go and click down in these different segments and try to understand, is [it select demographics] that really are what’s driving it? And while it’s true, there are more Millennials, and they’re growing at a faster rate as part of digital-type households, the average balances are still lower from a Gen Z or Millennial household than they are for their non-digital [favoring] counterparts. And the margin spreads larger as you get into the Gen X and the Boomer [segments], so it’s not just a younger generation type of shift. [Digital] is smaller across the board.

The one kind of good piece that we did see was the primacy on those digitally originated accounts actually do pretty well. So you know, when you’re looking at primacy – now, part of that has to do with the fact that some of the customers have had a relationship with the bank and open a secondary [possibly digital] account with a bank  and so there’s some of that plays into it – but as far as the total relationship they have with the bank, being digital or non-digital could start one way and then expand another way.

Koning Beals: It’s part of the same question in a way, Tom, when we’re talking about quality, you examined checking account deposits and balances in detail for this latest snapshot. Share with us, please, some of those behaviors and trends.

Hoscheidt: Over the last several years, post pandemic, [the industry] has been [in] downward trends in terms of checking deposits. And the big question that the bankers had as we were showing some of these downward trends was, Well, what’s going to happen? Will we eventually start to see a leveling out? Are we going to start to see a return to a normal level of growth?

What the numbers are showing us right now is that we are returning to more of a normal level of growth, and that’s looking more positive for next year. So we think most of the negative checking account or checking balance growth is behind us and looking forward to positive levels next year.

Koning Beals: I’ve been thinking about fees, incentives, marketing around deposits. And I know, Isio, wrote about that topic for us in our BAI Executive Report outlook. [Plus], we just had news the CFPB put out its final ruling capping overdraft fees. So, just thinking about fees generally, incentives like I said, what in that area are you watching when it comes to banks growing their deposits?

Nelson: It’s all tied together. The story is not a new one, even if the CFPB [advances] regulations around it. So first of all, there are a couple of ways that banks make money, right? They have non-interest income and then interest income. And so the non-interest income, which is fee income – you’ve got ATM fees, account management fees… and overdraft fees and late fees… And of these that are being regulated, honestly, were kind of self-regulated [already] by the industry as the marketplace started to, you know, demand certain things.

If you had FinTechs marketing no-overdraft type of accounts [for instance], there was enough scale out there that the traditional bank said, Yep, it looks like this is something consumers want. They adjusted products and services to do that. Now with that, there are trade-offs … as income can’t be derived, there’s got to be other places it’s made.,

Koning Beals: Tom, we talked last podcast about this current state we’re in, with some uniqueness especially around short duration for CD, money market books [held at banks] right now compared to recent years. Any updates on that picture?

Hoscheidt: We took a look at durations, and over two-thirds of the balances in CDs were in durations of less than one year. A lot of those [CDs] either have come up for renewal or will be coming up for renewal in the next six months or so. There’s going to be some decisions to be made by the consumer and also by the bankers, generally speaking, if they want to hold on to those dollars. They can push the consumer one of two ways: they could push them toward more savings, money-market type of deposits, or they can perhaps offer a little better rates for the longer-term CDs and start to lengthen the overall maturity of [the bank’s] CD book. So again, we think that CD balance mix as a percentage of total deposits is going to begin its decline here as rates trend lower. But there’s going to be some consumers that are still trying to maximize on the way down their rate. And I that they will go for longer-term CDs as a result of that. And so the [average] book will, as I said, begin to get longer in terms of its overall term.

Koning Beals: Tom, it’s always a hard question asking folks to look as far ahead into 2025 as possible. But our constituents want to know what on the deposit landscape looms here?

Hoscheidt: Well, it is of course, going to be the speed with which the Fed brings down rates, okay? And then, of course, how banks react. One of the things that we looked at during the State of Deposits webinar was sort of the structure and how much liquid or near-liquid money banks had at relatively high rates. And so, as those rates come down, and they come down quickly, there’s going to be differing levels of risk and reaction to that by various banks, [including] their liquidity position. So, if they’re trying to hold on to those funds, they’re going to be more aggressive.

During the State of Deposits, we look historically at interest-rate cycles, and generally speaking, when the Fed Funds are above 2%, we tend to see a lower level of overall deposit balance growth, both on the small business side and consumer side. So again, rates are still going to be elevated well above 2% even at the end of next year. And so we’re anticipating that there’s going to be a lower level for all deposit balance growth during this period.

Koning Beals: I certainly hear optimism in your voice, Tom, but you know, a nice, fair dose of reality given an interest-rate picture still shifting. Consumers will still want yield as you’ve mentioned, so banks will have to be aware of a changing landscape, as they always are. That’s nothing unique to 2025.

I want to thank Isio Nelson and Tom Hoscheidt for interpreting the latest deposit data for us and I want to thank all who listened in. Remember, you can play on demand the State of U.S. Deposits webinar at bai.org under the Banking Strategies Webinar dropdown. And stay tuned for more periodic updates to the deposit picture in 2025. Happy holidays to all.