With the economic situation still uncertain more than a year and a half after the pandemic started, banks are facing challenges in trying to figure out how to position their institutions for the future.
In a recent webinar, I spoke with Darling Consulting Group President Matt Pieniazek and Abrigo Managing Director Dave Koch about how bank leaders can still capitalize on the current environment.
While we discussed an array of topics—from the need to reimagine what asset-liability committees can and should be to the importance of thinking differently about pricing—my top three takeaways were:
1) Focus on developing relationships with new customers
At the start of the pandemic, deposits at some banks swelled by as much as 20%. Today, excess liquidity remains a concern. However, it was still relatively recently that many banks had high loan-to-deposit ratios and were wondering where their next dollar would come from.
Bank leaders can think of their balance sheets as two separate financial statements: a traditional balance sheet and a COVID balance sheet comprised of assets and liabilities from new customers.
Hidden in those latter financial statements, one layer below the numbers, is a huge opportunity. Given the correlation between core deposits and franchise value, bank leaders can bolster their institutions for years to come by taking steps to develop strong, lasting relationships with new customers today.
Sure, those customers could withdraw their funds as soon as the economy improves. But even if they do, banks will be closer to winning their loyalty than they were before. During periods of financial or economic hardship, people have a way of remembering who was in their corner.
It’s also important to remember that, in a normal year, bank leaders would have to spend marketing dollars to attract these same individuals and businesses to their institutions. The fact that new customers are already customers (not prospects) represents an opportunity in and of itself.
However, if banks don’t act now to cultivate loyal relationships, they risk losing their new customers when the economy turns.
2) Derivatives deserve a closer look
Many bank leaders are reluctant to embrace swaps. Some think them too complex, others don’t want to deal with the associated regulatory burdens, and still others are concerned about exposure to credit risk or risks unseen.
At the same time, more bankers are using them and finding them beneficial. Swaps offer pricing flexibility and can free up capacity for fixed-rate lending. They enable banks to hedge against rising rates and give customers what they want. For instance, while banks may prefer variable-rate positions, particularly in a low-rate environment, customers tend to demand long-term, fixed-rate loans. With an interest-rate swap, both outcomes are effectively possible.
Now is a good time for bank leaders to reevaluate the use of swaps at their institutions. By modeling different scenarios with swaps on their balance sheets, they can start to understand when it makes sense to use them. If they aren’t using swaps, they should be able to explain why they aren’t and the conditions under which they would.
3) Review sources of wholesale funding
In a healthy economy, loans outgrow deposits—the question is when and by how much. If banks suddenly find themselves in a situation where money is going out the door, they may need to replace deposits with funds that offer a spread. Many will not be able to exit certain asset positions (and they may not want to).
Of course, wholesale funding is also a great tool for managing interest-rate risk—much more so than retail deposits.
Given that we are in a once-in-a-century funding environment, now is the time for bank leaders to take a harder look at their sources of funds and funding strategies. They could find ample opportunities to lock in low rates, refinance higher-cost funding, and diversify their funding sources.
Now is the time to prepare
The current environment poses many challenges. With the future uncertain, bank leaders should be taking steps to prepare for a rebound when it comes.
And they should be mindful that, often times, the greatest risk to an institution is the risk of doing nothing. This axiom holds true particularly during times of economic uncertainty, which can not only cause business disruptions, but also have a paralyzing effect on decision-making.