How Higher Interest Rates Can Disrupt the Fintech Business Model
As the Federal Reserve begins to withdraw the punch bowl and raise interest rates, will competition for deposits reassert itself through new digital channels or has our relationship to savings changed? for ever ?
The last time inflation was the main economic concern in the United States, the fed funds rate peaked at nearly 20% to tame it. In more recent memory, the Federal Reserve raised interest rates 17 times from 1.0% to 5.25% between 2004 and 2006 to cool an overheated economy, triggering a wave of bank balance sheet restructurings in the process. But for more than a decade, interest rates have been so low that maximizing returns on cash is not something consumers have given much thought to. But as the Fed begins raising rates by 0.5% or even 0.75% in back-to-back meetings this spring and summer, the ripple effect could upend the business plans of fintechs and banks. .
Much of what we now consider the fintech and digital banking industry was created in a period of essentially free money, in which the difference in net interest margin between balance sheets funded wholesale and retail has been minimal. Instead, the focus has been on digital customer experiences and product innovation as traditional banks struggle to keep up. Nothing demonstrates customers’ lack of attention to savings rates like the more than $2 billion that Starbucks customers are currently lending interest-free to the coffeehouse chain by leaving money in the mobile app, or the tens of billions of dollars in uninsured cash balances sitting on the PayPal Balance Sheet. When a savings account earns a fraction of a percent, it’s simply not worth actively managing your money between transaction accounts and savings accounts.
What makes the near future so difficult to predict is that no one in the industry has a clue how sensitive deposits are to interest rates in a world of two-minute digital account openings and one-click account links through services like Plaid. The brief rise in rates in 2017 and 2018 suggests that overall savings rates in the 1-2% range aren’t enough to break consumer inertia, but what if runaway inflation drives rates back down. savings in the 3-4% range? and the inflation-adjusted cost of leaving money in a zero rate account becomes closer to 6-7%? This is an opportunity cost that consumers are likely to start paying attention to.
In this environment, digital banks that have relied on paying nothing for customer deposits, but instead made money from interchange fees and surcharges, may find that balances begin run off trading accounts in search of a better return. If digital banks then try to retain those deposits through attractive savings rates, they will need to do something creative on the asset side of the balance sheet beyond simply investing in portfolios of low-risk securities. Similarly, digital credit providers who have funded themselves at low cost in wholesale markets will see their funding costs rise sharply in line with the federal funds rate, while banks’ more diversified funding mix may mean that their cost of fund grows much more slowly, creating a financial disadvantage for monoline lenders.
One of the consequences of a decade of cheap money is that many in the banking industry have forgotten the true power of a traditional integrated bank balance sheet. In particular, branch networks have long served as the flying paper for low-cost transaction deposits, and although the relationship between local branch density and deposit share has weakened over the past decade, studies consumption shows that many individuals and small businesses still appreciate the convenience of having their money in a local institution that they can visit. In return, they will often leave excess funds in low-yielding checking accounts rather than seek better rates.
As rates rise, one scenario is for traditional banks’ transaction deposits to remain largely passive, leading to higher net interest margins as they revalue asset portfolios. But there’s another scenario where the combination of eye-catching savings rates and increased digital fluency creates a “money in motion” phenomenon where, rather than trading meme stocks on Robinhood from their couch, consumers are looking to move their savings with a few clicks on their phone to maximize their money return. There are already startups like maxmyinterest.com working to facilitate this optimization and many new stablecoins offering a quick 5% return if you put your money with them.
If the inert deposits of US banks are at stake for the highest bidder, then many of today’s bankers are going to have to learn a new set of skills – how to compete for liabilities. Banking analysts will also have to dust off their deposit beta models and rediscover the mysterious art of analyzing deposit rate sensitivity. However, even in this competitive scenario, banks are now armed with an array of analytical tools and customer data that will allow them to actively manage their liabilities rather than being passive observers of money in motion. Big banks now have a much better understanding of customer account inflows and outflows and can counter deposit leakage to connected accounts with targeted offers and promotions.
A rising rate environment also creates a temptation to take the lead from the Fed and create a splash. With no risk of cannibalization to worry about, a major US bank recently launched a new savings account in the UK paying 1.5%, well above prevailing rates offered by competitors and the equivalent of killer paper. digital flies. It could be a smart move if the Bank of England matches the Fed on rate hikes, but it could also be a high-cost customer acquisition gamble if rate hikes are lower or slower than expected. This year.
We are about to enter a period where access to the best savings rate will require you to simply tap your phone rather than perusing the latest pages of the the wall street journal. Whether the last decade of digital banking has reduced friction and incentivized consumers to actively manage their savings remains to be seen. If so, the banks at the top of Bankrate.com could see a tsunami of hot money deposit inflows. Regardless of rate sensitivity, it would be prudent for retail bankers to start thinking seriously about liability product design, rate tiering, and how to proactively guide consumer decision-making via mobile apps before they have to react on the fly. to serious money in motion. The bitter irony of the next few years may be that after educating consumers on the ease of digital banking, it may be venture capital-backed fintechs that will find it hardest to compete in a rate environment. rising sharply.