In today's financial landscape, we're seeing a convergence of factors that will drastically impact the banking industry. With interest rates rising and non-bank competition on the rise, it's more important than ever for financial institutions to be prepared for what's to come.
But what exactly can we expect in the near future, and how can banks and credit unions stay ahead? Let’s explore the banking industry’s expectations around the convergence of 5 key factors impacting what will likely be referred to as “the Great Money Migration.”
Watch the full webinar recording of The Great Money Migration featuring Neil Stanley of The CorePoint to learn more about the current paradigms, challenges/threats, and opportunities ahead.
1. Magnitude of financial opportunity
The financial opportunity in the next four to five years will be much greater than what we have seen in the past 15 years. The interest rates will be higher than before, which will impact the volume of deposits and interest rates that banks can offer.
While the low cost of funds is a part of profitability, minimizing it can be a disaster. In fact, it's important to find the sweet spot—an oversized volume with an undersized cost of funds. This is because no profit can come from no volume, and it's crucial to strike a balance between the two. Therefore, it's important for banks to focus on maximizing their volume while minimizing costs, rather than solely minimizing costs.
Additionally, the banking industry has become commoditized, making it difficult for consumers to differentiate between banks. Even if a bank is doing things differently, consumers expect little difference in the deposit accounts offered by various banks. This creates a challenge for banks to make their offerings understandable and attractive to potential customers.
2. Non-banking competition
The financial landscape is evolving, and non-bank competitors are becoming a real threat to traditional financial institutions. Inflationary pressures have led to an increase in I-bond purchases. While there is a $10,000 annual limit per social security number, the fact that investors are directed to treasurydirect.gov is a cause for concern as it enables them to buy treasury bills, notes, and yields without the need for a broker.
In addition to the threat from non-bank competitors, the government is now competing with financial institutions by offering yields of over 4%. This competition could prompt financial institutions to offer callable CDs, which pay even higher rates than standard CDs, and non-insured savings opportunities. However, while these options may appear tempting due to their high interest rates, it is important for financial institutions to educate their customers about the risks involved, such as the lack of FDIC insurance.
To compete against these emerging threats, front-line staff in financial institutions need to stay informed and educated about these new developments. They need to be able to answer questions and address concerns about the safety, soundness, and insurance of different investment options. Educating customers on the risks and benefits of various investment products can help ensure that they make informed decisions and protect their finances.
3. Regulatory changes
The regulatory changes in the financial industry over the past decade have led to significant shifts in the way commercial accounts are handled. The Federal Reserve lifted its regulatory prohibition on paying interest on commercial deposits in 2011, making commercial accounts much more attractive to commercial entities. As a result, financial institutions can no longer rely on these accounts being free or close to free, and may need to compete more fiercely to retain their commercial clients.
Another important regulatory change occurred in April 2020, when the Federal Reserve eliminated transfer limits on savings accounts. While many financial institutions chose not to change their policies during the pandemic, this change is likely to have a significant impact on depositors' awareness of their options in the near future. Financial institutions will need to balance the desire to restrict withdrawals with the risk of alienating depositors who may see better options elsewhere.
Overall, these regulatory changes are increasing depositors' awareness of their options and making them more price sensitive. Financial institutions will need to be vigilant in their efforts to retain clients and remain competitive in a rapidly changing landscape.
4. Open banking
The concept of open banking is gaining popularity among bankers who believe it will enable efficient money management and help build stronger relationships. However, the reality is that open banking can make it easier for customers to sweep money in and out of their accounts, leading to reduced account balances for financial institutions. As a result, banks may not want to keep transaction account balances when they can pay lower rates for insured options that are paying higher rates. This could lead to a situation where banks keep the transaction account, but the balances used to fund loans sit in another financial institution.
While open banking has the potential to drive industry collaboration and financial wellness for all, it can also impact price sensitivity. Depositors may efficiently and effectively sweep funds to the highest bidders, making deposits much more rate-sensitive than in the past. This could lead to a depletion of value as people start harnessing this ability to move money. Banks should, therefore, carefully consider the potential impact of open banking on their business and ensure that they are not naively assuming that all fintech activity will be beneficial to them.
While the fintech world is offering various money management tools to minimize the likelihood of overdrafts, it is easy for customers to sweep out excess balances into higher-yielding offerings. Hence, any depositor could leverage these tools to create sweep accounts, which did not exist when rates were over 2.5%. Overall, banks need to look at the situation and consider the potential impact of open banking on their business, including the possibility of reduced account balances due to increased price sensitivity.
5. Social media
Social media is going to play a crucial role in spreading the word and encouraging individuals to put their money to work amid the Great Money Migration. This movement will not just be led by the financial industry, but by everyday people who want to help their friends and loved ones make their money work for them.
For example, many people hear, “Put your money to work,” and think it means, “Put your money at risk.” So for the last 15 years when they heard someone share this advice, they thought someone was trying to suck them into a risky endeavor. Today, there are options available that offer a yield of close to 5% with zero risk. Now, people will be telling their friends, “Don’t leave money uninvested.”
Financial institutions are keeping the fact that businesses can earn interest on their deposits on the down low. But what if businesses started recognizing this fact and moved their deposit funds to other institutions offering fair interest rates? This could change the migration of money and encourage people to put their money to work. All of these changes are out there, and it is not clear how they will play out, but one thing is for sure, social media will be instrumental in spreading the word and encouraging people to take action.
Preparing for the Great Money Migration
The banking industry is bracing for significant changes in the coming years. With the increase in interest rates and the rise of non-bank competitors, financial institutions need to prepare themselves to stay competitive. Given this shift in financial behavior—the Great Money Migration—it's crucial for banks and credit unions to anticipate and adapt to the changes to remain ahead in the game. Ultimately, being aware of these changes and adapting to the evolving financial landscape will be essential for the banking industry to thrive in the years ahead.
To learn more about current financial institution trends, including previous webinars featuring Neil Stanley, check out our webinar library.
