Rising interest rates put a spotlight on banking innovation | So Good News

Let’s face it: watching interest rates over the past decade has been like watching paint dry. After the Great Recession, the Fed kept rates close to zero and let them dry up for years.

The recession and subsequent regulatory changes forced banks to focus their efforts on risk and compliance. More importantly, as the industry grew accustomed to low, flat rates, product innovation became a celebration. Low rates made it impossible for banks to make money on deposit accounts, so many banks sought revenue by streamlining and streamlining individual products—a strategy that ultimately led to silos.

But all that is about to change. Both interest rates and inflation are rising. The industry is entering a work environment it hasn’t seen in years. In our mercurial digital world, where yesterday can seem like last week and last week like last year, high interest rates can feel like never before. The youngest banking executives have only experienced a world of high rates in the history books.

Higher rates are a game changer. Deposit accounts have regained economic value, moving banks away from a niche product focus and back to a holistic view of the customer. This remarkable reawakening brings product innovation back into the spotlight for banks.

Here we see three streams that have emerged from their efforts to date.

1. Breaking down product silos to meet holistic customer needs

Near-zero interest rates have distorted the consumer market, prompting banks to focus on individual products rather than the consumer as a whole. In a world where indicators are growing, the shortcomings of this approach are being exposed. Tomorrow’s leaders will focus on bringing both sides of the customer balance sheet together to create value.

Some banks are ahead of others in this regard. For example, Bank of America has achieved nearly 99% customer retention by packaging its products with an integrated loyalty program that recognizes the customer for the total value of their deposits and loan products. The more deposits its customers keep in the bank, the better rates they get and the better they rate. Smart grouping of assets and liabilities allows the bank to find value both for itself and for the client.

But this is the exception rather than the rule. Banking requires an Amazon Prime-like approach for today’s consumer. Bankers should explore linking deposit products to other lines of business, such as tying the number of deposits to larger payout rewards, or lowering mortgage rates or rewarding customers for the total value of their deposits and bank lending.

2. Creating the haves and have-nots in banking

Rising rates reminded bankers of the eternal truth that not all deposits are created equal. As a general rule, the stickier the deposit, the better, and the stickiest depends on current accounts. These accounts have a lower deposit beta – a fraction of the changes in the federal funds rate that banks must pass on to their depositors.

Differences in deposit beta create a set of haves and have-nots. Banks with sticky, low-beta branch deposits face less pressure to raise account rates as the Fed raises rates. They also have greater flexibility in creating loyalty programs that combine deposits and loans to bring new value to banks and customers.

Conversely, if you’re a “hot money” bank with a high beta, you’ll pay dollar for dollar as rates rise. As a result, the top of Bankrate.com is the most dangerous place to be in banking right now. If your name is on this list, it means that you have to pay money every day that rates rise to keep the deposits you have.

The average annual percentage rate (APY) on a US savings account is currently 0.21%. The average APY for the top 10 hot money banks offering short-term deposits at above-average interest rates is a staggering 3.16%.

This spread forces banks funded by hot money to think in new ways. New focus on affiliates, teaser rates, bundled rewards and more. Look for deposit product innovation like

3. New opportunities (and risks) in M&A.

The impact of higher rates on the M&A ecosystem may have their greatest strategic implications. History has shown that higher rates unleash a wave of M&A, as it gives commitment-rich banks a once-in-a-decade opportunity to improve their long-term return on equity, balance their loan portfolios, and reduce their reliance on commercial credit. .

For example, during its last significant growth cycle in the early to mid-2000s, Capital One made excellent use of smart acquisitions to transform itself from a monoline lender into a true multipurpose bank. Some of its competitors, such as First USA and MBNA, did not and were acquired.

Today’s ecosystem can be a great opportunity for mid-market banks that don’t face the capital constraints of the big players to consider buying monoline lenders or fintechs that are struggling to operate and self-fund in the face of rising rates.

Time to dig out your history books and put on your thinking caps. After a long absence, banking innovations are in the spotlight. It is a dangerous, stressful and exciting time.