In the last four years the world has experienced unprecedented disruption that resulted in a global economic slowdown and rising inflation. In a bid to combat the threat of recession and control inflation the United States Federal Reserve raised the federal funds target rate 11 times between March 2022 and July 2023. The interest rate has remained steady at 5.25% to 5.5% since July 2023.1 But in March 2024, the Fed indicated the possibility of three-quarter point cuts by end of this year. These cuts are yet to be implemented, but the possibility of interest rate changes has significant implications for banks and highlights the dynamic and volatile environment they operate within. Changing interest rates impact markets and customers in different ways and commercial banks must have the flexibility to quickly adapt and restructure their strategies to keep pace. Above all, this volatile macro environment requires banks to focus on innovation and value-driven offerings.
The Impact of Lower Interest Rates
Before we dive into what banks can do to counter interest rate fluctuations, it is important to understand how interest rate cuts will impact the economy, consumers, and banks. Customers will benefit from the lowered interest rates as loans will be cheaper. They may also explore refinancing options at this time. And returns from savings are likely to be lower, but the overall increased spending will benefit the economy. For retail banks, lower interest rates will pinch profit margins, but the increased demand for loans may help offset that. Banks may also invest in securities to maintain profitability. Commercial banks are likely to the feel the pressure on the Net Interest Margins (NIM), which may affect profitability. Commercial lending is likely to increase but banks must manage interest rate risk by carefully adjusting their asset-liability mix. Lower interest rates can also lead to reduced customer loyalty as customers may look for the best returns elsewhere and contemporary technology makes it easier for money to flow in and out of different banks. Customers may also consider investment products, resulting in commercial banks competing with non-bank organizations as well as fintechs.
What can Banks Do?
Commercial banks must overhaul their strategies to remain profitable when interest rates drop.
- Diversify Revenue Streams: As interest rates go down, customers are more likely to consider increasing investments, and will need financial planning advice. This is a good opportunity for banks to focus on offering fee-based services like advisory services ranging from cash flow management, treasury management advisories, business advisory, and investment planning. Banks can focus on cross-selling and bundled service packages that include multiple banking products and services for a monthly or annual fee.
- Reinvent Account Analysis: For decades, account analysis has been done in the same old-fashioned way. Most banks only focus on the billing portion of account analysis. But a robust, modernized account analysis function can reinvent the entire process by addressing not just the monthly billing, but instead link the entire customer lifecycle from sales to implementation – pricing, accurate statement delivery, collections, and even product price review and customer renewals. By eliminating the disjointed, disconnected systems used to perform these tasks today, banks can not only find significant efficiency and error reduction, also plug significant revenue leakage found in most legacy account analysis processes. Modern account analysis focuses on the customer rather than the bank’s processes, delivering real-time information, helping corporate customers with better cash forecasting and liquidity management, and ensuring accurate invoicing to plug any revenue leakage while increasing customer loyalty. By revamping and reinventing the account analysis function banks can expand their services to offer third-party services, effectively leverage customer data to improve the customer lifecycle, and most importantly, ensure accurate billing and statements. A modernized account analysis function can be a game changer for commercial banks and help protect their revenues from interest rate volatility and market disruptions.
- Offer Soft Earnings Credit (EC) Combined with Hard Interest: Earnings Credit has long been a uniquely American thing when it comes to account analysis. It originated from regulatory restrictions on paying interest on demand deposit accounts. Those restrictions have since been repealed, but Earnings Credit can still be an important tool in a bank’s overall rate offerings as it is one of the least expensive ways to compensate customers for their balances. Even though rates have been high, many customers seek ways to get a higher real return on balances as opposed to the soft credits against service fees that Earnings Credit offers. Smart banks now offer a combination of Earnings Credit and Hard Interest to their most valuable corporate customers, through multiple EC or Hard Interest account types. The most innovative offer combinations of the two as a Hybrid Interest account.
- Get Customer Commitments: One strategy used by successful banks with their corporate customers is to offer specialized rate opportunities either for Earnings Credit or Hard Interest based on transaction or balance commitments made by the customer. This is an effective method of hedging the risk of offering higher rates, by guaranteeing additional revenue streams that can offset the cost of offering higher rates to these customers. However, this will only be effective if the bank has the capability to not only set commitment expectations, but also monitor and enforce them over the life of the customer’s relationship.
- Human-Centric Banking: Customers today are spoiled for choice when it comes to their banking needs with fintechs offering them products and solutions designed to meet their unique requirements. If commercial banks are to retain and grow their customer base amidst falling interest rates, they must up their personalization game. They have a wealth of customer data at their disposal that they must deploy advanced data analytics and AI to get a comprehensive idea of customer engagement across the bank as well as their requirements and preferences in the given context. This is the foundation for crafting hyper-personalized and relationship- based offerings ranging from pricing to offers and bundles. Human-centric, relationship-based banking can help deepen customer relationships amidst rising competition and an increasingly volatile market landscape.
- Revamp Deposits: Armed with a better understanding of customer needs, banks can revamp their deposit portfolios (business checking accounts, business savings accounts, cash management, treasury management services, etc.) to deliver what customers need. Some may prioritize interest rates, while others may focus on value-added services (such as identity theft protection, credit monitoring, and financial planning assistance), which can be bundled with existing products for an additional fee. The flexibility to understand what customers want and tailoring offerings to meet their needs is important for ensuring customer satisfaction and an effective business strategy for growth. It may also be important to leverage price elasticity models or analytical optimization tools to reduce errors and subsequent revenue leakage.
The Tech Foundation for Banking Innovation
Legacy banking technology platforms lack the agility and visibility into customer data to roll out diversified offerings in response to market conditions. This ability is crucial for long-term growth and profitability. Transforming the banking core can be a daunting task because of the associated risks and costs. But the good news is that banks no longer need to touch their legacy cores to modernize their technological capability. They can work with a specialized solution provider to deploy a robust, cloud-native, API first, and micro-services-based platform that can help them update their revenue management strategies and roll out data-backed and hyper-personalized innovative offerings that meet customer needs. In essence, these new-age products can serve as an agile middle layer, effectively orchestrating the complexities of the bank’s legacy systems into well-structured rate and fee management capabilities.
The U.S. banking sector has been experiencing significant upheaval over the last few years. A long period of high interest rates, followed by a potential drop only adds to the volatility of the banking landscape. At this juncture, it is crucial for banks to focus on innovative new strategies that put customer needs first to protect and grow their revenues and profitability.
