Regional banks have come under major stress in recent months, and while the situation appears to have stabilized, they face challenges ahead. That includes grappling with rising interest rates, attracting and keeping deposits amid tough competition from money market mutual funds, and a potential recession.

To gain a better sense of how regionals are navigating the current environment, I recently spoke with Tim Wennes, CEO of Santander US, for an episode of Banking with Interest. We discussed deposit competition, whether federal regulators will raise capital requirements, the bank’s approach to auto lending, how to target Gen Z customers, and much more.

What follows is our conversation, edited for length and clarity.

"While the events of March were idiosyncratic to specific institutions and their business models, we expect greater pressure on margins and higher funding costs going forward."

The past few months have been challenging for banks between $50 billion and $250 billion in assets. Santander US is in that category. What has been your experience?

We’ve navigated the challenges quite well. As a wholly owned subsidiary of a global systemically important bank, our capital and liquidity requirements are similar to those of large global U.S. banks, so we're in a strong position. Also, our deposits have been relatively stable, as nearly two-thirds are FDIC-insured, and we have a very diversified deposit base. That’s important because deposits are going to contract under quantitative tightening. This already started happening last year. Deposits are even more competitive today than they were pre-March, which means liquidity will become increasingly important. That’s going to constrain loan growth—not just for regional banks, but for all banks.

What’s the best way to compete for deposits?

Relationships are important. So are services. For banks, having operating balances with companies can create stability and security. The cumulative impact of Fed moves over the last 14 months has created meaningful opportunities in cash alternatives. Also, with the digitalization of banking, online offerings have become far more prevalent, making it easy to move money and take advantage of rates. Hence why depositors can get FDIC-insured CDs at 4% or more for the first time in 15 years.

Do you think the turmoil in banking is over?

What we are seeing is relative stability in the marketplace. While the events of March were idiosyncratic to specific institutions and their business models, we expect greater pressure on margins and higher funding costs going forward. We saw some NIM expansion last year, and that’s starting to flip. We’ll also need to keep our eye on commercial real estate and office exposure, as there are clearly challenges in that segment.

Do you think federal regulators will raise capital requirements?

Many experts are reviewing and opining on what may come out and the impacts. From our perspective, we would urge policymakers to be thoughtful about any policy response and look at what tools were available that could have been more helpful in preventing this. Blanket approaches of more capital or liquidity requirements will impact the industry's ability to lend and increase the cost of capital, among other implications. We all want the industry to be safe and sound. Banking is about trust and confidence. At the same time, our job is to facilitate commerce, help companies grow, and provide capital to the markets.

You're saying there's a balance.

Indeed. A bank can only grow its loan book to the extent it’s growing its deposit book. If deposits shrink (to be expected with quantitative tightening) there's not going to be rapid loan growth. In fact, bank balance sheets may contract. That's going to slow the economy and help the Fed tame inflation.

You told American Banker in April that Santander US was becoming a “full-spectrum auto lender that goes beyond subprime lending and includes prime and super-prime borrowers.” What's behind that shift in strategy?

Historically, we did a lot of business with super prime mainly on new cars, and we did lower-credit lending primarily on used cars. Santander Consumer, our auto business, used to be a separate, publicly traded legal entity. Last year, we took it in house and became a 100% owner. Now we're leveraging our bank deposits to help fund some of those loans. This allows us to be more competitive across a broader range of FICO scores, including in used-prime and other near-prime segments

You published results from a survey in March that found roughly three quarters of middle-income Americans believe a car is key to job opportunities and job security, and that two-thirds would sacrifice other budgetary items to access and maintain a vehicle. What does this tell you?

Employment status, and the unemployment rate, are key drivers of payment behavior. Over 70% of our customers for auto loans are middle-income. We want to understand how they're thinking in this unique environment, where there’s high inflation but strong employment. Our mission and vision are focused on helping consumers and businesses prosper, and how consumers are thinking about the future is important for us as we develop products and services for them.

"Technology is rapidly changing customer preferences and behaviors. Gen Z consumers who grew up with technology expect banking to be similar to shopping on Amazon or an experience on Instagram..."

The survey also found that 69% of respondents are worried about a recession. Are you preparing for that possible outcome?

We’re preparing for more difficult economic conditions in the future, whether that means an actual recession or not. Economists have been predicting a recession in three to six months for over a year, but the economy has been resilient. We’re optimistic, but we’re also being thoughtful about where and how we're deploying our capital while ensuring we’re comfortable from a liquidity standpoint.

Sixty-three percent of Gen Z expects financial prosperity in 5 years, according to your survey results. What does that mean to you?

It’s great to see that statistic, especially so soon after the pandemic, during which the Gen Z population was really negatively impacted. In the United States, our optimism, resilience, and adaptability are our greatest strengths.

Do you worry Gen Z customers will go to fintechs, Apple, or Big Tech—or whichever shiny nickel of the moment—instead of banks?

I think about that every day. Technology is rapidly changing customer preferences and behaviors. Gen Z consumers who grew up with technology expect banking to be similar to shopping on Amazon or an experience on Instagram, and the banking industry will need to deliver on that.

How do you target the younger market?

We want to try and get them early. At the same time, with financial services, people's needs change, and their financial position gets more complex over time. We need to understand our value proposition, how we connect with that marketplace, and how we add value.

From a deposit standpoint or a credit card standpoint, getting in early is important. But in the auto business, when somebody needs a car, they're going look for a loan that may or may not come from where they typically do business. Same with a mortgage. Technology has made it possible for people to choose where to shop for the products that make the most sense for them.

Has the electric-car revolution impacted your auto-lending business?

We are doing lending on EVs. The question more so than EVs is whether ride sharing, car sharing, or a subscription type of ownership will evolve. We do a lot of business with Uber and Lift drivers in the ride-share environment. We also do lending for commercial and fleet. So we are being vigilant and prepared as the industry evolves.

The dealer experience is really important and continues to evolve, too. Through the digitalization of that experience, we can improve outcomes for dealers and customers. We've partnered with a firm called AutoFi to set up a portal where a customer can apply for a loan, we can get them credit approval and the dealer can tell them which cars they're qualified for and what their monthly payments would be.

What are the main challenges with commercial real estate?

I think it's important to break down commercial real estate into segments and not think about it all as one bucket. There’s multi-family, industrial, retail, office, and so on. Segments like multi-family and industrial are really strong. The main challenges are around office, given the rapid rise in interest rates and post-pandemic work environment. Many companies are going to need less space over time.

Why did Santander Bank recently exit the mortgage business?

We want to focus on businesses where we have scale and are globally connected with Santander Group, our parent company. Mortgage didn't fit that, and heading into a cycle of rate increases, we knew the business would get more competitive. When we started thinking about investments, we couldn’t see earnings above cost of capital and decided it was better to exit. We can still provide mortgages to our customers, but we do it through a partner instead of owning the process ourselves.