That is a critical question as many deposit products are near-perfect substitutes from a consumer perspective. Today, as we are about to start experiencing sharply rising rates for the first time in years, it’s time to revisit the need to project the impact on the various Deposit offerings – with similar return/liquidity characteristics – of the expected rate movements. Accurately understanding your deposits’ sensitivity to cannibalization, i.e., the money flows out of one deposit product into another deposit product and even flows from loans to deposits and premature redemptions is not a “nice to have” but critical information for proper ALM and managing the overall customer/member experience.
The first quarter is traditionally the big deposit season, and this year it is expected that the Feds will announce their first interest rate hike after three years of easing. For Finance and Marketing executives across the financial industry, repricing our portfolios raises the dreaded question: How much will deposit cannibalization cost us as rates rise?
Why deposit cannibalization matters
Deposit cannibalization is vast. Under normal conditions, about 30% of all observed deposit account balance growth is funded by internal money flows. Introducing new deposit products, or repricing existing products disrupts the norm, and cannibalization can shoot up to as much as 80-90% of deposit balance growth in new deposit products.
Deposit cannibalization can be expensive. The features and pricing that make new deposit products attractive to consumers come with a cost, e.g., liquidity premiums, price matching premiums, hedging costs. When these costs are fully considered, new deposit products often have a lower contribution margin than other products your customers/members already hold. When money flows from higher to lower margin products, it increases your all-in cost of funds, lowering profitability.
Transactions fragment member behavior making cannibalization difficult to measure. Money flow analysis solves the problem.
When consumers move money into, out of, and between deposit products (an example of what we call member behavior), they often gather money from multiple sources (new money, other deposit, and loan accounts) into their Checking or Savings accounts en route to the final product or service account they want. That usually requires several transactions to achieve the desired outcome of the funds arriving at their ultimate destination accounts.
Core systems record each transaction as a debit or credit event without capturing or tracking the original source(s) or ultimate destination(s) of the money in motion. . So that is the first problem: cannibalization money flows are not captured by core systems. The second problem is that the transactions that are recorded cannot be matched because they have a “many-to-many” relationship that cannot be solved programmatically.
The bottom line is:
- banking systems cannot measure deposit cannibalization flows, and
- transaction analysis is not an optimal source to understand cannibalization.
Bankers rely on transaction analysis as a proxy but sacrifice accuracy. As business competition accelerates, ignore accuracy at your peril.
Traditional ways to track deposit cannibalization money flows.
Most credit unions and banks do not have any means of tracking deposit cannibalization money flows. At best, they follow new money deposit transactions and assume that “the rest” of deposit growth was funded by money flows resulting from deposit cannibalization. A host of issues arise from this approach, which is costly and imprecise (stay tuned, as we will write about it in a future article. Or, better, talk to us about how to address this issue.).
First, this analysis lacks critical information about which products are the sources and destinations of deposit cannibalization money flows. Without knowing the source products, it is impossible to understand the impact on contribution margin and funding costs incurred when deposit cannibalization occurs.
Some may argue that cannibalization money flows would have gone to competitors if they did not introduce new products/pricing – and they may well be right some of the time. Yet few banks and credit unions can test this assertion because they don’t have an advanced econometric model of price elasticity of demand for the entire market- credit unions and banks – tailored to their market area. What matters is that deposit cannibalization money flows have an actual cost, and understanding those costs is essential information for marketing, product management, pricing, and treasury decision making.
Tracking deposit cannibalization money flows – problem solved!
If you want to be truly member-centric, you MUST understand member behavior, which makes it imperative to increase the rigor of how the deposit portfolio is managed. We say you must measure money flows at the account level to support analysis by:
- customer / member (who),
- the product (what),
- branch (where) and
- time period (when).
The types of money flows should distinguish between actual new money deposit flows and money moving between accounts – cannibalization, product substitution, account substitution.
FlowTracker Analytics’ patented analytics solution does that and more; it also tracks
- new money,
- deposit-to/from-loan money flows and
- separates routine fluctuations from significant behavioral changes so you can focus on what matters.
Our solution is actionable, accessible, and affordable. A trial with your data can be completed in a few weeks at a nominal cost without impacting your architecture. If you want to increase your ability to zero in to satisfy your members’ financial needs better and improve the effectiveness of your actions, let us have a conversation. We would love to hear from you!