Three questions with Mac Thompson, founder and president of White Clay, on building a recession strategy
White Clay is a firm that provides consulting services and customized software for regional bank partners. In this week’s Q&A, White Clay's founder and president Mac Thompson dives into what banks can do to manage a likely recession and avoid the mistakes that framed 2008.
What goes into building a recession strategy?
To optimize capital and manage profitability during a recession, banks and credit unions should start by re-evaluating their asset and liability strategy and how that impacts their pricing strategies. Accurate pricing involves having a clean data environment, which can be accomplished with the help of modern technologies and fintech partnerships. This environment enables banks and credit unions to create a holistic view of customers’ banking relationships. Having more visibility into these relationships helps financial institutions determine how clients impact liquidity and risk, consume capital, and provide revenue, as well as which are most profitable.
When relationships are priced properly, banks and credit unions will also have a better idea of how to build and execute deposit strategies, which will be key during the upcoming recession. For the past 14 years, financial institutions' pricing strategies have been focused on loans and fees, but the environment has now changed due to the pandemic stimulus, the increase in cash supplies and historic levels of inflation. Because of this, banks and credit unions will be on the hunt for deposits. As part of this hunt, they’ll need to create a deposit strategy that includes: 1) identifying where clients have deposits over their 3-6x monthly spending; 2) aligning this strategy with their asset and liability strategy; 3) implementing disciplined intentional deposit pricing processes and tools optimized by client segment and relationship; and 4) educating teams to understand, execute, and communicate these changes internally and to clients.
At the same time, banks and credit unions should also continue lending to avoid making the same mistakes as 2008. Customers will continue to need access to credit to succeed in the challenging environment. They will rely on their trusted bank or credit union for help. However, financial institutions should be disciplined about who they lend to. They must ensure the loans and lines of credit are priced appropriately to cover the liquidity, capital, and risk costs to deliver shareholder value.
Will each financial institution's recession strategy be different, and if so, how?
The basics of a financial institution’s recession strategy will be the same – optimally pricing loans and deposits according to their institution’s strategy. Effective pricing strategies can help financial institutions better optimize their capital during a recession. Banks and credit unions are much more familiar with pricing loans, given how low deposit rates have been for over a decade. The biggest shift for institutions will be learning how to build and execute a deposit strategy while being much more conservative with lending than they have traditionally been.
Deposit strategies will vary based on each institution’s assets and liability strategy. For instance, a bank may want to increase loans by 20%. This will require liquidity for which they can tap into the Federal Home Loan Bank (FHLB). However, if they run out, they’ll need another source of funds, and can look into the marketplace for deposits, although this is a much more cost-prohibitive option. So, the best option is to have a steady stream of deposit income that will allow them to finance loans, which is how banks make money.
The way financial institutions determine relationship value will also dictate how they price deposits. Is a long-term relationship with a client worth risking over pricing changes? Probably not. If they do decide to price relationships differently, financial institutions will need to clearly communicate internally and externally about rate changes and adjust them quickly while applying proper credit for deposit balances and service fees.
What are the biggest challenges in creating a recession strategy that works? What are some pitfalls to watch out for?
Perhaps the biggest challenge is that most financial institutions don’t have a recession strategy in place today. Banks and credit unions should be proactively preparing now; this includes preparing their data to be able to optimize client relationships and track performance at an organizational level. Employees will need to have a better understanding of how to talk about both deposit and loan rates, as well as recommend products and services that will deliver value to clients and shareholders. Organization-wide strategic alignment will be required to execute any recession strategy. These strategies will take a considerable amount of time and effort, which is why they should be prioritized now.
The second biggest challenge is not having a clean data environment. Many banks and credit unions don’t know which customer relationships are primary or secondary. A clean data environment, enhanced by advanced intelligence, will help banks and credit unions create strategies to optimize these relationships while providing better service to customers. This intelligence will also enable banks and credit unions to determine which relationships produce the most revenue and need to be protected, as well as which could benefit from increased engagement – both will be important in a recession.
Financial service use continues to unbundle – what does that mean for retail banks?
Across the globe, more customers are turning to different financial companies for different financial services, according to a study by EPAM. On average, consumers hold 2.4 products or accounts in addition to their primary accounts.
This puts retail banks in a pickle – as more consumers turn to other service providers for specific financial activities, retail banks lose out on key behavior insights, like spending habits.
With that being said, retail banks are still seeing a lot of trust from their customers – 79% of respondents reported trusting their primary financial services provider. It’ll be interesting to see whether banks will be able to fully leverage this trust to keep every aspect of their customers' financial activities.
What we’re reading
On Wells Fargo’s new digital banking platform (Finextra)
US banks with digital brands are figuring out how to appeal to consumers with new high-yield products (S&P Global)
Why banks should have their heads in the cloud (MIT Technology Review)
Neobanks are putting their focus on appealing to UK savers with high-yield savings accounts (CNBC)