Falling Federal Reserve and Treasury bond interest rates are putting pressure on banks to figure out how they’ll retain customers whose money is sitting in certificates of deposit that will soon mature. iStock illustration

The Federal Reserve’s fall rate-cutting cycle has local banks staring each other down. At stake: shrinking profit margins and access to the deposits they need to make money.

While most banks are looking to see who will strike first and cut rates, proactive institutions that look past merely mimicking their competition can go on the offensive and lower their costs.

And for local banks and credit unions, the relationships they have built with customers give them added some leverage to make these bold decisions while adding to their bottom line. Banks who take an analytical approach can gain edges which can lead to more profits, consultants say.

How Banks Set Deposit Rates

Typically, local institutions look at competitor offerings and movement from the Fed to determine deposit rates. Additionally, the cost for banks to borrow from the general market impacts the rates they can offer depositors.

“Obviously the main driver is, what is the Fed overnight rate and what are alternative sources of funding? Meaning, what can we borrow from the general market, whether that’s brokered deposits or the Federal Home Loan Bank or the swap curve?” said Leader Bank President Jay Tuli. “And so, if there’s a huge gap where you can borrow a lot less, then it doesn’t make sense to offer really expensive deposit rates if there’s other cheaper sources of funding.”

How a financial institution determines its rates can be determined by its strategic goals. An institution looking to strengthen its balance sheet might have a different strategy than a bank or credit union with a different loan book.

“I think every bank does look at this differently, depending on how much of that margin they need to protect and how quickly they need to stay on top of rate decreases,” Hometown Financial CEO Matt Sosik said. “The other obvious thing that the other obvious driver here is the fact that none of us are banks in a vacuum, and there’s competition everywhere. The reality is that all of us smaller community banks, all of us are price-followers.

Boston-based consultancy Darling Consulting Group reported that six-month Treasury rates fell 50 basis points this past summer and currently sit below 4 percent. Yet more than half of all banks and credit unions in late November were still offering a certificate of deposit rate above the six-month Treasury rate, said Managing Director Joe Kennerson.

Bankers Face Unfamiliar Terrain

The current rate environment and competition for depositors have forced banks and credit unions to act more cautiously when it comes to dropping rates, said Darling Consulting Group Managing Director Bill Guthrie. The current falling rate cycle that bankers find themselves in is different than what most are used to managing.

“What we’re used to is rates essentially going back to zero and deposits flooding in at a very cheap cost,” Kennerson said. “We’re still in an environment where rates are anywhere from 3 [percent] to 4 percent probably over the next year. There’s still opportunity for customers to get yield, and they’ll look at it.”

When rates on CDs fall, depositors have less incentive to roll their money over into a new one when their last CD matures.

“But if an institution is lowering their CD rates, they’re getting less activity on the CD side and then the best offering that they have in their portfolio, like their money markets or savings [accounts interest rate], is sub-2 percent today,” Kennerson said.

The net result if depositors see less reason to keep money in CDs? Banks’ pool of reliable deposits shrinks, shrinking the money they can loan out to earn interest income.

Darling Consulting Group’s research says CD products have a renewal rate over 90 percent.

Analytical Approach

Local banks and credit unions wanting to get ahead should look beyond simply what their competition is offering, Kennerson and Guthrie said, and use data to see where an edge can be gained in deposit management.

“It’s a new era,” Kennerson said. “What we have found, quite simply, is that when you introduce these hard data analytics to the conversation, it does take some of the emotion out of the game.”

The future of banking is data-driven, said Cambridge Savings Bank Executive Vice President Angela Conti, who heads the bank’s consumer- and small business-focused arms.

Sam Lattof

“Data sounds impersonal, but I feel like there’s so much data about how individuals and human beings are interacting with us that it does allow you to better personalize,” she said. “I don’t want to pretend like I don’t look at what’s out there, but it’s not the single driving force, because what we really want to do is make sure that our customers are receiving a very fair rate on their deposits and very fair pricing on their loans, and that we’re able to serve their needs and the additional benefits that they’re looking for.”

Some Bankers See Edge in Emotion

But as Massachusetts’ banks and credit unions size up their competition and their options to retain deposits, some bank leaders say they have another way to gain an edge on their competitors: the interpersonal work done by bank employees to build customer relationships. A customer who is invested in a bank’s ecosystem of products and has received quality service is much less likely to depart an institution solely because of declining deposit rates.

Additionally, relationship banking can help build some leverage for banks when it comes to deposit pricing, Hometown Financial Group’s Sosik said. If a bank is able to provide value through its suite of products or general service it can potentially look to lower its cost of funds by reducing deposit rates somewhat without fear of customers bolting.

“We bring value across the relationship, and it allows us some pricing flexibility,” Sosik said. “It’s easier to do on our on our commercial customer base, because we have more touches with them, and we’re typically in closer contact, so it’s easier to bring value that allows us that pricing leverage.”

Building these relationships are crucial in a banking environment where individuals searching for the highest rate can find it online, Leader Bank’s Tuli said. If local institutions are simply looking to compete on rate, it is likely a losing battle.

“I think all banks at the end of the day, they want to build a sticky client,” Tuli said. That, stickiness of clients is very important to profitability, and the way you build the stickiness is by growing your relationship.”