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Strategies for a Low-Rate Environment

In my last post, we reviewed possible interest rate scenarios and their impact on bank profits. In this post, we’ll outline some of the initiatives Treasury Strategies has been helping its clients deploy to address the opportunities and threats of a low-rate environment, detailing the first step of the approach – rigorous modeling.

In the face of a reduced value placed on commercial deposits, banks must take decisive action to sustain profit and position for growth.

1.     Understand the impact of macro scenarios on business economics
2.     Restructure product pricing/rate structures for better profit and lower risk
3.     Refine relationship profitability metrics
4.     Improve efficiency
5.     Train the sales force to get paid for value

Treasury Strategies believes the macroeconomic impacts of high liquidity, sluggish GDP and low interest rates will be severe for most banks and could be catastrophic for those banks heavily dependent on spread revenue. The first step a bank must take is to understand and quantify the potential impacts of these scenarios.

Understanding the Impact

Effective modeling will stress test the customer portfolio and P&L under multiple macroeconomic and regulatory scenarios. An effective modeling approach should enable the bank to test new pricing schemes, incorporating switching behaviors, attrition and share of wallet dynamics. Once impacts are defined and understood, managers can plan mitigating strategies. An overview of a model is shown below.

The schematic to the right illustrates the components of rigorous deposit modeling and while it holds true for all market segments and product types (e.g., consumer, small business, corporate, institutional), the drivers and variables obviously differ by context.


1. Macroeconomic ScenarioThe macroeconomic scenario has multiple impacts – the level of rates and the shape of the yield curve have a wide range of impacts that must be considered. Furthermore, the macroeconomic scenario has strong correlations with many other model components. Below is a partial list of impacts.
A. As shown in the last blog post, rate structures and liquidity levels drive funds transfer pricing – the value placed on deposits – thus driving revenues.
B. The absolute level of liquidity and the level relative to loan demand and banking assets and capital strongly drive the intensity of competition for deposits.
C. The level of liquidity is a major determinant of the percentage of non-analyzed customers that will achieve balance thresholds for various package services that permit offset of fees. For clients using analyzed packages, the level of liquidity will affect offsetting earnings credit and thus hard dollar fees.


Regulatory Scenarios
Regulators are actively changing the economics of the business. Because many elements of regulation are not yet final, these factors must be estimated as a series of probabilities or risks to be mitigated. For example, the Basel III liquidity coverage ratios may result in additional costs or discounts to transfer pricing levels for certain deposit relationships.
3. Competitive ScenariosCompetitors – including substitute products such as mutual funds, money market instruments, local government investment pools, debt retirement and stock buy-backs – will offer propositions to the market and will market and sell these propositions with varied success. The attractiveness of your bank’s offer will be evaluated against the context of competitor offerings – in other words, if customer behavior is the demand curve, supplier offerings are the supply curve.
4. Market Demand DriversMany banks make the mistake of using elasticity analyses to model customer behavior. While these elasticity approaches are a useful component of a model, they fall short in several key respects. First, because these models are historical, they fail to capture discrete changes in customer behavior, such as the massive shift that took place in 2008 in the demand utility functions for counterparty risk and liquidity. Secondly, by modeling the bank’s portfolio, these studies reinforce weaknesses in the bank’s portfolio. We worked with one bank that was overly reliant on rate-sensitive, shallow relationships and had pursued an elasticity-based model. The elasticity-based model simply reinforced the bank’s strategy, continuing to destroy shareholder value by promoting strategies reliant on interest rate competition.

For this reason, the model must infer demand utilities and customer behavior that are forward-looking and based on the aggregate market. The natural question is: how can this be done?  There are a variety of research techniques that can be used to infer forward-looking utilities. Treasury Strategies deploys data mining to empirically identify customer behavior and research approaches such as conjoint studies to predict future customer behavior. Knowing how your customers are currently managing their cash – not just within the bank, but also outside of the bank – provides unparalleled insights into the demand behavior of the portfolio.

5. Product Structures and Pricing/Rate LevelsFacing revenue pressure, many banks have aggressively deployed non-analyzed checking packages and modular bundles in a drive for customer growth, fees, balances and cross-sell. Banks are also assessing the optimal structure of their earnings credit rate programs and the positioning of ECR relative to other rates, including interest checking, MMDA, sweep, repo, Eurodollar deposits and time deposits. By varying rate structures and package scope, the bank is making a series of trade-offs.
A. By changing product structures and price levels, a bank encourages some customers to shift among its various product propositions. A classic example of this dynamic is a bank that aggressively deploys robust deposit packages, cannibalizing analyzed accounts.
B. Product structure and price levels, relative to substitute products and the competition, can drive customer acquisition levels, share of wallet, attrition and cross-sell. Consider for example, a change in product structure that requires customers to bring in a higher balance level or pay a fee. Some of these customers will respond positively by bringing in additional balances or paying a fee, while others will attrite (in whole or in part), leaving the bank for a competitor or substitute offering.
C. Lastly, while models deal in data, it’s critical to consider the impact of the product structure and price levels on the bank’s operating model. Are the products easy to sell?  Is it easy to get the client into the right product and fully cross-sell the client?  Implicitly or explicitly, the model must consider the impact of the product structure on the ability and capacity of the bank to sell, retain and cross-sell via various channels (branch, banker, specialist, direct).


Cost Dynamics
Marginal cost dynamics are generally poorly understood within banks. However, capturing the marginal operational costs and the staff level of support for selling, implementing and servicing clients is a key component of profit.
7. Funds Transfer PricingThe value placed on balances can be the single greatest driver of profit. Ideally, this valuation should be dynamically constructed as part of the model, taking into consideration macroeconomics, regulatory requirements and the likely behavior of the deposits, based on the target market and proposition.

The form of the model can vary, but for large portfolios typically involves either a database or a random sampling technique that simulates aggregate portfolio change by calculating impacts at an individual customer level. In the most advanced cases, Treasury Strategies has constructed models that permit the introduction of variables as distributions (normal and non-normal) and correlation matrices across variables. In these cases, the output of the model is a density function (distribution), showing not only the weighted expected outcome, but also the potential positive and negative outcomes at various probability levels.

As can be seen, the modeling of a deposit portfolio – particularly under an unusual regulatory and macroeconomic environment – is a non-trivial matter. But understanding future outcomes and the interrelationship between these variables is critical – in today’s world, acting without this information is akin to driving on the freeway while blindfolded!


In the next post, we’ll cover additional actions that banks should take, once they’ve diagnosed the impact of the low-rate environment. To learn about how Treasury Strategies is helping clients thrive in the low-rate environment, contact us at

Dave Robertson


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