In 1946, Hungary’s highest denomination bill was the one hundred quintillion pengo, a massive step up from the 1K pengo note of 1944. This was the worst case of hyperinflation ever recorded. At its peak, prices doubled every 15.6 hours, or, in other words, the daily inflation hit 195%. In comparison, the US’s post-pandemic inflation pales in comparison, yet it has been deeply felt by millions of Americans and, of course, by the financial sector.In the first of three articles, we review some of the key challenges that have shaped the financial industry this year and look at some of the strategies community financial institutions (CFIs) have adopted to overcome them.1. Economic Uncertainty, Inflation, and Higher Interest Rates In September, inflation hit a three-year low of 2.4%. However, the effects of prolonged high inflation are still being felt, as prices are 21.4% higher than at the start of the pandemic. In November, consumer sentiment, which dipped halfway through 2024, rebounded to 71.8, reflecting some optimism about the economy going forward. Indeed, despite continued geopolitical shocks, real GDP is expected to expand by 2.6% in 2024, an upward revision from 2.4%. Although the Federal Reserve cut interest rates by 75bp between October and November, rates have remained high.CFI Strategies:
- Building stronger relationships with SMBs. Small and medium-sized businesses (SMBs) have been particularly affected by the turbulent economic conditions: a Goldman Sachs study earlier this year found that 77% of SMBs were concerned about their ability to access capital. CFIs have been supporting SMBs with loans, treasury management, and cash flow management, as well as providing financial education and specialized guidance.
- Investing in digital transformation. Many CFIs have turned to technology to drive efficiencies, streamline processes, and engage and attract customers in cost-effective ways. According to Cornerstone Advisors, 90% of banks and 95% of credit unions are pursuing a digital transformation strategy, with the average digital spend per $1B in assets nearly quadrupling in the last two years.
2. Increased Cost of Funds and Intensified Competition for Deposits Despite the Fed’s rate cuts, CFIs are still battling with the rise in cost of funds. According to the Conference of State Bank Supervisors (CSBS) 2024 community bank survey, nearly nine out of ten respondents rated cost of funds as either “extremely important” or “very important”, topping the list of external risks to their business. With rates peaking in 2024, customers have been increasingly shopping around for better deals, and CFIs have faced fierce competition not only from their peers but also from the higher-yielding options in the Treasury and money markets.CFI Strategies:
- Employing tailored pricing strategies. Since depositor sensitivity to interest rates varies, price sensitivity analysis has allowed CFIs to strike a better balance between customer retention and net interest margins.
- Making use of rewards and incentives. Some CFIs have boosted their deposits by offering rewards checking accounts, which provide higher interest rates in exchange for greater engagement. Others have offered free gifts or cash incentives.
- Leveraging brokered and reciprocal deposits. According to the CSBS Community Banking survey, nearly half of CFIs have turned to brokered and reciprocal deposit networks, despite some lingering concerns about their reputation.
3. Liquidity Pressures Alongside higher funding costs, CFIs have faced pressure on liquidity while regulators are encouraging them to hold more cash and maintain multiple avenues to access funding. In CSBS’s survey, liquidity was rated as either an “extremely important” or a “very important” internal risk by 78% of respondents. Although lower than the 84% recorded in 2023, the figure is still more than double that of 2022.CFI Strategies:
- Increasing monitoring of CRE portfolios. Traditionally more exposed to CRE than larger banks, CFIs have taken decisive steps to mitigate risk in this area, by increasing portfolio monitoring and tightening lending policies, while leveraging their intimate knowledge of their local markets and communities.
- Using Federal programs. CFIs have also taken advantage of various initiatives, such as the Bank Term Funding Program (BTFP), introduced by the Fed. This program, which ended in March, allowed banks to access liquidity against high-quality collateral.
- Focusing more on risk management. Many CFIs have refined their asset-liability management (ALM) strategies by employing dynamic scenario analysis, enhanced their stress testing to better understand potential risks, and diversified their investment portfolios when concentrations proved too risky.
US financial institutions have faced a complex landscape in 2024 driven by economic uncertainty and the effects of persistent inflation and high interest rates, leading to continued competition for deposits, high cost of funds, and liquidity pressure. CFIs have responded by adopting a number of strategies, including supporting SMBs through these challenging times, embracing digital to drive efficiencies and boost customer engagement, employing diverse deposit strategies, and increasing their focus on risk management. Keep an eye out for our second installment of this three-part series reviewing 2024 trends for CFIs, out next Tuesday.
