In 1851, Linus Yale Jr. introduced the "Yale Infallible Bank Lock", a design that allowed owners to change its combination and concealed the keyhole behind a hardened steel plate for enhanced security. Despite such innovations, the 19th century saw a continuous battle between lock manufacturers and thieves, with each advancement in security met by new methods of breach. This ongoing struggle was even showcased in events like the "Great Lock Controversy" at the Great Exhibition of 1851, where American locksmith Alfred Charles Hobbs successfully picked a lock considered unpickable, highlighting the perpetual challenge of securing valuables. Much like the evolving challenges of physical security in the 19th century, today’s financial institutions must navigate a rapidly shifting deposit landscape. The rise of digital banking and fintech platforms has transformed depositor behavior, making it increasingly important for community financial institutions (CFIs) to adapt their strategies to manage the cost of funds and remain competitive. This challenge has been a top concern for CFIs in 2023 and 2024, as rising rate sensitivity, digital banking adoption, and evolving depositor expectations continue to reshape the industry. To stay ahead, CFIs must understand these structural shifts and develop sustainable funding strategies.The Growing Cost of Funds and Deposit CompetitionNearly 90% of community banks identified cost of funds as a very or extremely important issue, according to the Conference of State Bank Supervisors' (CSBS) 2024 community bank survey. This proportion has nearly doubled since the 2022 survey, reflecting both rising funding costs and heightened deposit competition.The cost of funds has more than tripled since 2020, increasing from 0.74% in December 2020 to 2.85% by March 2024. As rates increased, depositors became more rate-sensitive, leading to greater money movement between banks and non-bank financial institutions.Shifting Depositor Behavior: A Structural ChangeHistorically, deposit rates followed a slow, predictable cycle, with customer movements largely driven by bank-led pricing decisions. However, since 2022, digital tools and fintechs have accelerated deposit flows, making customer behavior more dynamic and unpredictable.
- A growing proportion of deposit outflow events involved instant transfer apps like Zelle or Venmo, enabling same-day transfers.
- Deposit beta surged from 0.25 before the 2022 Fed funds rate hikes to 0.5-0.6 in 2023, meaning rate hikes are passed to depositors much faster.
This represents a fundamental shift in how depositors behave — CFIs must adapt by offering competitive products and leveraging customer relationships for retention.Three Critical Questions Before Raising Deposit RatesWhile higher rates may seem like the easiest way to compete for deposits, CFIs should consider three strategic questions before making pricing decisions:1. Does your institution need additional deposits?
There’s only one fundamental reason to spend money on attracting deposits: because your CFI has profitable ways to deploy them. Assess your overall funding strategy, including:
There’s only one fundamental reason to spend money on attracting deposits: because your CFI has profitable ways to deploy them. Assess your overall funding strategy, including:
- How much funding is needed for loans and other profitable uses?
- How much of your current deposit base is at risk of outflow?
- What alternative funding sources exist, such as correspondent banking services, liquidity lines, or structured funding solutions that may provide flexibility while maintaining deposit pricing discipline?
2. Are you reacting to market data or individual complaints?
Some institutions feel pressured to raise rates when a competitor does or when a single high-value customer demands higher returns. However, with today’s digital landscape, high-rate depositors are the most likely to move their money elsewhere at the next opportunity. Instead of chasing rates:
Some institutions feel pressured to raise rates when a competitor does or when a single high-value customer demands higher returns. However, with today’s digital landscape, high-rate depositors are the most likely to move their money elsewhere at the next opportunity. Instead of chasing rates:
- Use data to determine competitive but sustainable pricing.
- Explore diversified funding options that align with long-term profitability and risk management strategies.
3. How can you optimize your deposit strategy?
Attracting large-balance customers with premium rates is tempting, but these customers are more likely to move their funds quickly when rates shift. A more sustainable strategy is to:
Attracting large-balance customers with premium rates is tempting, but these customers are more likely to move their funds quickly when rates shift. A more sustainable strategy is to:
- Reward customers who use multiple products, such as treasury management services, commercial loans, or wealth planning.
- Incentivize relationship-based deposits over rate-driven accounts.
- Consider requiring a depository account with every lending relationship. Breaking down silos between different departments can help identify your CFI’s best customers and create a strategy that looks at the entire customer relationship.
- Ensure deposit gatherers are being appropriately incentivized through product pricing and funds transfer pricing.
Strategic Takeaways for CFIs
- Cost of funds has risen significantly, and depositors are more rate-sensitive than ever. CFIs need a clear funding strategy before aggressively pursuing new deposits.
- Digital banking and fintech platforms have made deposit flows highly dynamic. Offering niche digital banking solutions and real-time payments may help retain customers.
- Rather than chasing rate-sensitive funds, CFIs should focus on relationship-based deposits. Encouraging client engagement and establishing primacy with them as their main financial institution can increase the client’s net value.
By adapting to this new deposit environment, CFIs can optimize their balance sheets while maintaining a competitive edge in an increasingly volatile financial landscape.
