Earlier this year, The Federal Reserve in an effort to combat rising inflation announced that it would be raising interest rates to levels potentially not seen since 2008. This news is disrupting a recovery period marked by record low interest rates – hitting 0% shortly after the start of the pandemic.
It’s clear this new rate volatility will impact the economy, but what’s less clear is what this means for banks and credit unions.
To better understand the biggest threats and opportunities facing financial institutions as interest rates rise, we sat down with Narmi Co-Founder Chris Griffin to discuss the best deposit strategy to deploy, the window of opportunity for banks and credit unions, and which digital investments to focus on.
Raising and lowering interest rates is one of the main levers the Federal Reserve has in influencing the direction of the economy, so this current reaction by the Fed to shrink the economy and lower inflation is not particularly noteworthy. “What stands out this time,” Chris explained, “is that it comes at a time when most financial institutions remain flush with deposits.”
Still feeling the benefits of the deposit growth brought on by various stimulus and pandemic-related economic packages, most institutions we speak with explain how there’s been less of a need to grow deposits. When financial institutions are flush with deposits, lending becomes the focus. However, with more people carefully watching their spending during these uncertain times, it’s also meant that consumer demand for loans has softened. For most institutions, loan-to-deposit ratios have hit a low point.
Even though institutions aren’t currently focused on deposits, it would be unwise to overlook the deposit cycle on the horizon. As higher interest rates return, so too does the incentive for people to switch banks in order to make the most of their savings.
In order to know how to navigate the changing landscape, it’s important to anticipate the possible threats, and start looking for ways to take advantage of the emerging opportunities.
The good news is that the window for reacting and adapting to higher interest rates will likely remain open for a few years. This is due in part to the Federal Reserve being fairly predictable and reliably sticking with its announced forecasts. Additionally, most megabanks have signaled that they plan on being slow to raise deposit rates as fast as the Fed. But even though there’s time for industry leaders to react, making improvements now will give community banks and credit unions a leg-up when competition picks up.
Despite banks and credit unions not currently focused on the need to increase deposit growth, Chris notes the threat institutions could face if they get complacent in this area: “You need the members and customers to generate that loan demand. And there’s going to be opportunities for you to be on the receiving end of people changing banks due to the interest rate environment.”
Even though megabanks are expected to raise their rates slower than the Fed, the real threat facing community banks and credit unions comes from Challenger banks and deposit-taking fintechs. Untethered by traditional balance sheets, Challenger banks are able to move faster than the Fed as a way to stay competitive.
“If the Fed is willing to pay 2.8% on overnight funds,” Chris notes, “there’s going to be a bank out there willing to pay 3% – or even more.”
When it comes to which factors actually impact a person’s decision to switch financial institutions, qualities like digital features and access to a well-designed mobile app play a larger role than competitive rates for most consumers. But as Chris points out, entering a period of greater volatility in the industry may change the equation.
“Hedge funds and market makers love volatility,” Chris explains, “because that’s when they’re able to find the dislocations more frequently, and take advantage of them. Similarly, with the rate volatility in banking, there’s going to be a lot of opportunities in terms of acquiring new customers, generating new deposits, and actually monetizing those deposits.”
And as those competitive offers start appearing, Chris predicts that higher interest rates will factor in more for people looking to make a switch. “I suspect that if some financial institutions are able to offer 3-5% on savings accounts, you’re going to hear about it quite a bit among your friend group, or read about it on forums or in the media. Even if it’s not a life-changing amount of money, it signals that the bank can offer more in terms of your long-term financial goals.”
Regional and community-based financial institutions aren’t new to the existential threats that come from a competitive digital banking landscape. But as Chris points out, “The vast majority of community banks and credit unions completely blow Challenger banks out of the water in terms of features & functionality.”
As competition increases with more people looking to optimize their financial lives, community-focused institutions can outperform both megabanks and fintech challengers by leaning into the relationships they’ve built: Relationships built on trust.
“For our financial institutions, the majority of them understand that having a strong digital value offering is now expected,” Chris shares, “They have to have a really trustworthy digital experience that people find intuitive and well-designed – coupled with the fact that these community-focused financial institutions can typically serve their particular niche of the market better than anyone else.”
Attracting new users is one thing, but giving them an experience that builds confidence and trust helps these new users see your institution as a partner for long-term financial health. A great digital account opening experience bridges the gap between your marketing messaging and your banking services. It signals to new customers that your institution is willing to invest in the experiences that make banking less stressful, and mastering financial wellness more achievable.
Becoming the trusted hub for someone’s financial journey means more opportunities to be there when they’re ready to tackle big life moments, like buying a new car or first home.
Even though the window of opportunity from higher interest rates will likely stay open for a while, making improvements in areas like digital account opening now will result in future success for institutions. The simple reason for this is that better experiences build trust.
“Community banks and credit unions are investing in more than just this medium-term opportunity. They’re also creating this great onboarding experience for the long-term,” says Chris. As for a sense of urgency around timing, he explains that, “this current moment and opportunity justifies doing it now versus waiting for the future.”
It’s easy to overlook your institution's branding or push it to the bottom of the priority list, but investing in your bank or credit union’s brand pays off in the long run. Banking relationships are built on trust, and your brand is that foundation of trust for your customers and members.
“You have to build a relationship to become the hub of someone’s financial life,” says Chris. At the same time, he points out how credit unions and banks don’t necessarily have to undergo a drastic rebranding exercise to make a difference. “They don’t need to completely rename, or completely change, but if an institution hasn’t refreshed their brand in the last 5-7 years, it may no longer be meeting consumer expectations.”