The US banking and financial services sector has faced unprecedented disruption over the last few years. The chaos of the pandemic was followed by rising inflation and the risk of a global economic slowdown and recession. Today, the sector is still impacted by events in the macro environment, ranging from regional conflicts, geopolitical tensions, and even climate change. The good news is that inflation is showing early signs of slowing down. But this also means that a change from the record high interest rates may be around the corner. Commercial banks must now understand the volatile economic environment they are operating within and move quickly to keep pace and adapt to change.
The Evolving Interest Rate Environment
Let’s begin with a quick dive into the interest rate environment. The US witnessed unprecedented inflation, economic turmoil, and the very real possibility of a recession in the wake of the pandemic. To counter this, the United States Federal Reserve raised the federal funds target rate 11 times between March 2022 and July 2023. The rates have held steady since July 2023, ranging between 5.25 percent to 5.5 percent.1 But this year inflation rates are slowing down and nearing its target of 2 percent. And while the Fed continues to hold short-term interest rates steady, 2 Fitch Ratings expect the Fed to cut interest rates twice in 2024 – once in September and again in December.3 Lowered interest rates will drive an uptick in commercial lending, but also put Net Interest Margins (NIM) under pressure, impacting profitability.
The Impact on Deposits
The Fed began Quantitative Tightening (QT) in June 2022 and cut its balance sheet by USD 74 billion a month in 2023. As of July 2024, the central bank’s assets stood at about USD 7.2 trillion down from its peak of USD 9 trillion.4 Commercial deposits in the US represent half of total deposits. This fell by 10 percent between the first quarter of 2022 and the third quarter of 2023. Economists predicted that the Fed would phase out QT eventually. And this helped boost deposits that started rising again in the fourth quarter of 2023. Deposits may be rising at the moment, but customers are becoming increasingly price sensitive and banks will need to implement nuanced, value-driven deposit strategies to engage meaningfully with them.
New Growth Avenues
Evidently, commercial banks must rethink and revamp their strategies to address the challenges thrown up by the uncertain interest rate environment. A shift to customer-centric deposit strategies with the intent of improving customer experience is crucial now. Banks must focus on improving transaction banking and cash management practices with customer-centric innovation at the core of all they do. Product innovation, tapping into the emerging API economy, exploring embedded banking, generative AI, and digital banking innovations can help open new sources of revenue and drive customer engagement and satisfaction.
Transforming Treasury and Corporate Banking Services
At the same time, banks must focus on transforming existing processes and practices to deliver the level of service that customers need. In fact, these practices can prove to be a game changer for banks struggling to grow their revenues and profitability. Modernized treasury services with a focus on a digital account analysis function is one such area that holds immense potential for banks. The ability to understand their cash availability is a key customer ask and 49 percent of banks agreed that cash forecasting was crucial for corporate customers. Unfortunately, only 38 percent of banks are equipped to deliver this. This is a significant gap for banks as customer-centric transaction banking and treasury services can unlock almost than USD550 billion in annual revenues.5 Banks must focus on expanding their transaction banking services to help customers better manage liquidity, with modernized cash management tools and supply chain forecasting, and sustainability metrics.
Revamping Account Analysis
A robust account analysis function is invaluable for providing real-time balance information that customers need for cash forecasting. In fact, this function holds a wealth of customer information that if leveraged correctly can help banks understand the customer lifecycle and needs better. They can then offer products and services to meet customer requirements and drive product innovation, and ecosystem collaboration. A robust account analysis function is not only invaluable for corporate treasurers, but also ensures customer satisfaction, operational efficiency, and eliminates revenue leakage.
Accelerating Technology Transformation
As the banking sector continues to face uncertainty and disruption, banks must prioritize their technology transformation journey. Unfortunately, despite the digital transformation progress made within the sector, 36 percent of commercial bankers reported that the modernization of account analysis function still lags other processes. The good news is that banks don’t need to touch the legacy core to modernize account analysis. Banks can choose to deploy a robust middle layer solution to deliver personalized and data-backed services that customers expect.
The US banking and financial sector is likely to continue experiencing volatility and change for the foreseeable future as the Fed moves to address economic challenges. Banks must be agile enough to respond quickly to market changes and possess the scalability and flexibility to roll out new offerings. Modernizing functions like account analysis can unlock new revenue streams and help ensure customer satisfaction and retention.
