Even if the Federal Reserve cuts its benchmark interest rate next year as predicted, banks may not in fact be able to realize lower deposit costs thanks to customer demand for high-yield products. iStock illustration

After the Federal Reserve hinted at three rate cuts for next year, Massachusetts bankers are hopeful that lower deposit costs are in the forecast, but deposit-gathering itself will remain challenging.

Banks all over the country have suffered margin compression due to high interest rates, making customers used to high-yield savings accounts, and borrowers’ lack of interest in loan refinances and new mortgages.

Before the Fed cuts its benchmark interest rate next year, Clinton Savings Bank President and CEO Robert Paulhus said that some of his competitors have tried to pull back on their special rates for certificates of deposits (CDs) as early as now, but it will not stop customers from shopping around for high-yield accounts to park their money.

“We are now at the peak of the CD specials. There was some pullback that we saw from several banks in the area from our weekly survey, and they have lowered their CD rates from being aggressive this year. The challenge that remains for banks is that customers are moving their money from non-interest-bearing accounts, such as money market accounts, into CD specials,” Paulhus said. “People are shopping for rates.”

In the third quarter of the year, the Massachusetts banks that successfully grew deposits were the ones that were aggressive in offering 4 percent to 5 percent annual percentage yields for CDs.

Some of the winners that saw around a 1 percent to 2 percent quarter-on-quarter increase in deposits included Brockton’s HarborOne Bank, Cambridge Savings Bank, Brookline Bank and Rhode Island-based Citizens, according to data from  these stock banks’ quarterly earnings reports.

On a national level, banks that operate digital-only banks have had modest increases in third-quarter deposits, but also saw a corresponding jump in deposit costs due to offering higher rates.

First Citizens Bank offered a 5 percent APY rate for its digital-only CIT Bank and saw a 44-basis-point increase in its cost of average total deposits, and Customers Bank which offered 5.30 percent APY for its online savings account, leading to a 1 percent increase in deposits, quarter-on-quarter, as well as a 13-basis-point increase in its average cost of deposits.

Paulhus said that online-based banks can focus on providing attractive rates as they do not have overhead expenses such as labor and fixed assets that come with operating a branch.

The past two years have been challenging for banks to retain deposits, he said, as more people are moving savings built up during the pandemic out of the banking industry and putting it either in the stock market or spending it on personal expenses as inflation remains a factor even as it has declined over the course of the year.

Deposits Still Leaving Banks

M&T Bank CFO Daryl Bible told the Goldman Sachs Financial Services Conference earlier this month, before Fed officials revealed their interest rate cut predictions, that senior leaders at his bank are worried about the risk of deposit “disintermediation.”

Disintermediation refers to the outflow of funds from deposits at financial institutions to investments yielding a higher return.

“The hardest thing to predict right now is the disintermediation of deposits. It seems to be slowing down – but we still have our [demand deposit accounts] shrinking, and you still have your CD book rolling,” Bible said. “That disintermediation is real and is still happening, and it is really hard to predict when that’s going to settle down and stop. It depends on the rate environment, and if and when the Fed starts to lower rates.”

Demand deposit accounts are ones where deposited funds can be easily withdrawn, such as checking and savings accounts, which takes off the pressure of paying off more costly interest rates in longer-term funds such as CDs.

Bible said the bank has seen DDA balances drop to 31 percent so far in the fourth quarter, from 33 percent in the third quarter. The New York State-based regional bank, which has a large presence in Massachusetts, is pushing for more funds to go to shorter-term money market accounts.

“We are consciously trying to grow deposits. We’ve grown both our consumer and commercial deposits in this quarter, increasing about 1 percent overall. We’re trying to figure out the mix of what it takes to grow those accounts so we can take out some of the non-client funding sources in an economical way,” Bible added.

Will Banks Face CD Rate Fight?

Anne Tangen, president and chief executive officer of Fall River-based BankFive, said she believes that senior Fed policymakers’ predictions of three possible 0.25 percent rate cuts next year may be good for reducing deposit costs as the bank reprices its CDs, despite strong demand for high-yielding accounts.

“Depositors are going to want to lock in higher rates for a longer term but all banks are going to react the same way because the high cost of funds hurts everybody’s profitability,” she said. “So, you’re constantly trying to make sure that you’re not hurting yourself, but you’re also not losing customers. It’s a fine balance. You have to sometimes meet the competition and sometimes you have to just negotiate with your customer.”

Nika Cataldo

But not everyone expects lower deposit costs next year. Clinton Savings’ Paulhus said he believes deposit costs may go “somewhat higher next year” if more customers gravitate towards higher-yielding CDs when some banks take the opportunity to lower their rates amid any Fed rate cuts.

“We don’t see deposit costs going down. More people are wise, moving from accounts that have less than 1 percent rate to accounts with an average of 5 percent rate,” he said. “There will still be the wholesale funding, but we are trying to minimize our costs. Ideally, we get all our funding from our customers.”

Paulhus said  customers may be lured in by higher-rate deposit offerings at digital-only or out-of-area banks, but at some point may find them inconvenient due to the lack of customer service and the presence of a community branch nearby where they can walk in and get answers to any of their questions.

“That is our advantage as community banks. We do not have stockholders that we answer to and pressure our growth. But we are here for our community, both in monetary and physical aspects,” he said.