State of Deposits: What’s on the horizon

Let’s talk about shifting deposit behaviors, including what it means to “rent deposits,” a certain number-to-watch at the Fed, plus we ask and answer: does primacy matter?

BAI’s Tom Hoscheidt and Isio Nelson join Senior Editor Rachel Koning Beals on the BAI Banking Strategies Podcast to dig deeper into a midyear snapshot of BAI deposit research.

Brought to you by Salesforce, this podcast explores deposit behaviors now and into 2025, especially the challenges and opportunities banks face in acquiring customers. Learn more about how CRM, AI and data can drive deposit growth at Salesforce.com/banking.

KEY TAKEAWAYS

1. Bank failures changed deposits: After the failures of SVB, Signature and First Republic, mid-tier banks were under pressure from investors and regulators to demonstrate a strong deposit foundation. That changed mid-tier pricing and prompted a cash buildup that rippled through deposits across the industry.

2. ‘Renting deposits’: Rate-sensitive funds — highly mobile, higher-wealth accounts, for example — tend to move around but only for a limited time. When there are fewer alternatives, that money returns to the primary institution.
3. Interest rates to shift behavior? Deposit behavior has stabilized in 2024 and is projected to continue into 2025, though gradually. Fed benchmark rates stand near 5% with one cut signaled for this year and more next year. BAI Research indicates that only when there is less than a 2% gap in the rate differential between traditional banks and direct banks does the larger tide of money flow back to primary institutions.

Transcript

[Rachel Koning Beals] Tom Hoscheidt leverages more than 30 years of research and marketing experience to direct BAI’s performance benchmarking.

And, Isio Nelson, as managing director for BAI Research, and after a couple of decades inside banks and fintech, you help decode that data for clients and our industry at large.

You both are fresh off the June installment of BAI’s STATE OF U.S. DEPOSITS WEBINAR, which hit on the latest for both consumer and small business deposits. By the way, anyone can play back that webinar. Go to BAI.org. Under the Strategies drop down and then under Webinar.

Webinar participants had a lot of questions. Even with some deposit stabilization, it remains an uncertain time for the Fed, and for banks. So that’s why it’s great to grab you both for a quick follow-up. And understandably, decision-makers want to look forward as much as possible. Tom set the scene for us and share that outlook from your vantage point.

[Tom Hoscheidt] I’d say overall it’s more positive outlook. We’ve just come through two years of record deposit loss after the pandemic. And you know, things are things are getting better. How banks respond to this is going to vary based on the size of the model and also what happens with the Fed.

We’ve eaten through the surplus that built up during COVID. But we’re still dealing with inflation. There’s still some jockeying out there in terms of what rates banks are paying. So let me talk a little bit about the size and model. You know, there’s a continuum, if you will. We have large banks that have relatively high brand share and key markets that’s on one end of the continuum. On the other end of the continuum, you’ve got direct banks with virtually no branches and so the model that the large banks have in the structure of their deposit portfolio is very different than what we see in the direct banks. The largest banks, generally speaking, are bringing in a lot of checking accounts. They’re turning those accounts primary and then they’re, they’re deepening the relationship selling in savings, and then perhaps a money market, perhaps even a CD, but overall, their portfolio is very structured and more weighted towards checking and savings balances.

On the other end of the spectrum, without having any branches, it is very difficult for direct banks to develop checking relationships, very difficult for them to generate primary relationships. So their portfolios are much more weighted towards CDs and or higher rate, savings or money market products.

So facing this rate environment, what the large banks have done, is given that they have a lot of this money that’s in liquid deposits at a low rate, as rates went up, they sought to try to protect their overall cost of funds. And also because they were primary and had the strong checking relationships, a lot of the money’s that built up during the pandemic stayed with their primary institution and the large banks had even more of a surplus and deposits than the super regional [banks] and the regionals and super community banks.

So [large traditional banks]… as rates started to rise, they lagged the market much more. And that gave rise to a lot of those liquid funds, which by the way they can afford to lose running off on the other end of the spectrum. This was a key time for deposit growth for the direct banks. And what they did was, of course, started raising rates right away, and they started reaping the benefits of the rate-seeking dollars from those larger institutions.

So again, now where we’re at is, there is more rate parity in the marketplace. The traditional banks have come much closer to where the directs are at in terms of interest rates, and so there’s not as much money in motion as there once was. Consumers are pushing a little bit more toward liquid deposits, and kind of waiting to see what’s going to happen.

You know, we talk about what happens with the Fed. It looks like we’re going to have at least one rate decline this year, but it’s going to take a while for rates to get back to the point where there aren’t more alternatives for the consumer on the table.

[Rachel Koning Beals] We are still above 5% with the Fed. Did you have a number in mind, when we will see deposit behavior change?

[Tom Hoscheidt] There’ll be a gradual change. But generally speaking we will start to see deposits build back up at primary institutions when rates get below 2%. For some reason, 2% in a number of rate environments [historically] seems to be sort of the magic number. Like I’ve said it’s already declining now, because of the rate parity in the marketplace and there’s not that surplus of COVID dollars out there to give away.

[Isio Nelson] And, Tom, you know, one of the things that we keep hearing about as kind of a wrench that got thrown in last year that was unexpected — although I would say in this industry, we always have to expect the unexpected because there’s always a crisis in this industry — was when the bank failures happened. And so that caused a lot of, you know, kind of trickle down effects from especially some of those super regionals, regionals and super community banks that had pressure from their investors and from regulators to make sure that they were at a point where they had enough deposits on hand that everybody felt comfortable. So they actually accelerated rates probably faster than we would have expected, which then, of course, had effects throughout the entire industry.

[Rachel Koning Beals] And speaking of unknowns, at the end of the day, you know, we are dealing with people here. Behaviors driving responses. Consumers are harder to pin down. Bankers may have seen a few more cycles. But there has been some counterintuitive behavior behind these deposits. Tom, you want to talk a little bit about that?

[Tom Hoscheidt] What’s counterintuitive about this is, rates are higher, so you would expect deposit growth to be higher. Okay. You’re paying more, we should see more, more deposit growth. But the other thing is, that while FDIC insured deposit rates are higher, there are other options that come on the table as rates rise like money market funds. And so with more competition for the dollars that are out there, we see this counterintuitive situation where rates rise and deposits going to traditional institutions actually goes down.

And again, that’s exacerbated by the large banks who had a big buildup in terms of deposits and a low rate environment for a long time. It was even bigger when we went through the pandemic, and then they’re slower to raise rates, and so they experienced more runoff than the other peer groups and definitely than the direct banks, as I said before.

[Isio Nelson] Tom, let’s not forget that usually the reason why rates are higher is because there’s inflation. So what the Fed is trying to do is bring down inflation, but what inflation is doing and especially in that mass market, it’s eating away at those consumer pocketbooks, whether they no longer have as much money to spend or save, and therefore, one of the reasons you don’t see as much in the deposit side of the house that’s in the bank is because there’s just less to be housed at the bank.

[Tom Hoscheidt] We saw negative growth last year for year for the mass market, [but] depending on the bank and what their rate strategy was, we did see positive growth in the mass affluent and the wealth segment.

[Rachel Beals] Inflation is a moving target for the Fed we know. So it sounds like a big unknown for a lot of reasons. If you’re nimble enough to move money around, different story, but not all consumers can. But inflation hurts the banks themselves too, right?

[Tom Hoscheidt] Oh, absolutely. I mean, it squeezes their margins. You know, as rates go up, it makes loans more expensive for the consumer and lessens their overall demand. So yeah, there’s a number of adverse effects as rates rise on the banks.

[Rachel Koning Beals] You know, we say a lot in this industry, any industry, it’s really about quality versus quantity, but you said something the other day that I sort of loved it was about the significance of merely “renting deposits.” Do you want to you want to talk a little bit about that?

[Tom Hoscheidt] One of the questions that we had during the webinars is, is this behavior going to continue and are those funds that moved from primary institution to non-primary going to stick and generally speaking, I’ve seen this a number of times over the years. Basically the money that moves is the rate-sensitive money and so long as rates are up, that money will stick around. But generally speaking, you’re granting that for a certain period of time, because once rates go back down again, and there are fewer alternatives on the table, what we’ve seen is the money does return to the primary institution, especially when rates are very low like we saw after the financial crisis.

[Rachel Koning Beals] We talked about this at the top but just to kind of sum up and it’s a hard spot to try to predict, for the Fed, and for our industry. But I’ve heard the words “stabilization” and “normalization” around deposits, and I don’t want to put words in your mouth, but how do you characterize the deposit landscape for 2025?

[Tom Hoscheidt] We think that deposit growth, again, just looking at history and what’s happened in the rate environment, as rates still remain somewhat elevated even though they’re coming down, that we will tend to see a lower level of deposit growth.

However, just given more rate parity in the marketplace, and the surplus COVID dollars, checking balances coming back more into pre-COVID territory, you know, where you’d expect them to be. We are going to see subdued deposit growth, but not negative.

[Rachel Koning Beals] And listen, I always want to know this. It’s related to our subject matter. It’s a tough question. Does primacy still matter? We talked about size of banks and model. So maybe it varies. And, Isio, please weigh in.

[Tom Hoscheidt] Yeah, primacy does still matter. We’re actually looking at possibly changing our primary definition for possibly having different primary definitions for different age groups, if you will. But generally, no matter how we slice it, whether we look at it from the checking account perspective, or from even the credit card perspective, we see deeper relationships, lower cost of funds, less attrition. So primacy still very much does matter. There just might be a slight tweaking in terms of the definition of primary going forward as we become more electronics and payments focused.

[Isio Nelson] Primary banking matters. A lot of people give me edge cases and tell us about what their kids do or how different consumers behave to maximize things. But listen a majority of consumers have a bank that they use pretty consistently. It’s very sticky. They’re not changing banks on a year to year or even decade to decade basis. They’re usually with that bank for a while. And that’s important. So it’s where the paycheck goes. That’s where they are spending their money at the gas station and the grocery store, you know, on weekends. And that does a lot for the bank to be able to have that relationship with the customer and keep those low cost deposits with them. So everything we’ve seen in the data set is primary matters. There is some shift, to Tom’s point, some of that has to do with check use going down and credit cards being used more, and things like that, but you know, it still matters what you think about that bank that you do most your business with.

[Rachel Koning Beals] Listen, State of Deposits, one of our most robust pieces of research. That’s what we based our discussion on here today, but listeners can find a lot more information there. Both in the research and the webinar. Isio, talk a little bit about what that webinar entailed and what that research offers.

[Isio Nelson] So this is great conversation. We focused a lot on consumer today, which is good. We also did a lot with the small-medium business. So if we ever get a chance we can maybe talk a little bit more about them specifically in a future podcast.

But yeah, the State of U.S. Deposits was something we started because there was a lot of questions going on when the bank failures happened last year. What was going on with deposits, why does it matter by the bank size, measured by the model, by the type of consumers, the wealth consumer versus the mass market. So we really wanted to start to deaverage the average and get the industry educated to better understand what’s going on.

And then as I said, you know the rate environment and what’s going on with consumers and you know, even as we see an election year coming up, there’s a lot of movement that happens here, so if something’s going to change, we want to make sure we’re staying on top of it.

[Rachel Koning Beals] That is our industry. Change. Tom, Isio, thanks for joining us. We’d love to have you back on BAI Banking Strategies Podcast.

[Rachel Koning Beals] Many thanks for joining us on the BAI Banking Strategies Podcast. I’m Rachel Koning Beals, senior editor at BAI. Have a great day.