US banks’ deposit operations have experienced a difficult few years, with total deposit balances declining 7 percent between the first quarter of 2022 and the third quarter of 2023. In 2022, the US Federal Reserve began pursuing quantitative tightening, or reducing its balance sheet by not reinvesting all the proceeds of maturing securities. It also started rapidly raising interest rates. Consequently, banks’ funding costs have risen, ratcheting up pressure on margins.
The Fed last raised rates in July 2023 and has signaled that it expects one rate cut this year. Quantitative tightening (QT) is also expected to end: the central bank started to slow the pace of its balance sheet reductions in June. As a result, commercial deposits at US banks ticked up 2 percent between the third quarter of 2023 and the first quarter of 2024, and they are expected to continue expanding for the rest of this year, potentially showing annual growth of as much as 4 percent. Emerging trends point to a similar annual growth rate for the next three years—although changes in the Fed’s actions would alter this forecast.
Boosting and retaining deposits and improving margins are likely to be top of mind for bank executives. They will need to consider nuanced deposit strategies, as clients’ price sensitivity regarding deposits has varied significantly as rates have risen.
For banks to thrive in this environment, it’s crucial that they develop and nurture deep relationships with customers, devise effective pricing strategies, and position themselves for long-term structural success by achieving the right balance in terms of markets and client segments.
The US deposits landscape
US bank deposits declined significantly in 2022 and for most of 2023 as the Fed pursued QT, but they began to recover in late 2023. Commercial deposits stabilized despite the challenges posed by the early 2023 regional banking crisis.
Hit by QT
The Fed began QT in June 2022 and cut its balance sheet by $74 billion a month, on average, in 2023. As of July, the central bank’s assets totaled about $7.2 trillion, down from a peak of nearly $9 trillion, and many economists predict that the central bank will phase out QT by next year. As QT ends, the outlook for deposits is expected to improve, and indeed they started rising again in the fourth quarter of 2023 after falling for six consecutive quarters.
Stabilizing commercial deposits
US commercial deposits, representing about half of the total, fell 10 percent between the first quarter of 2022 and the third quarter of 2023, then rose 2 percent over the next three quarters. Over those two periods, retail deposits remained flat, falling 2 percent during the first stretch before growing 2 percent during the second stretch. The growth in commercial deposits in late 2023 and early 2024 came despite the regional banking crisis in early 2023.
Aftermath of the regional banking crisis
Contrary to popular belief, the top four US banks didn’t gain a lot of deposits as a result of the regional banking crisis of early 2023. Between the fourth quarter of 2022 and the third quarter of 2023, US commercial deposits declined 4 percent. The top four US banks attracted only about 15 percent of those outflows. While balances didn’t significantly shift between providers, the turmoil in 2023 sparked significant interest in insured deposit products, particularly at regional banks. Commercial deposit outflows stabilized across all banking categories after June 2023.
Strategies for striking the right balance on deposits
To thrive in this competitive environment, banks need to build deep relationships with clients, devise effective pricing strategies, and position themselves for long-term success by pursuing the right markets and client segments.
Deeper client relationships
Deeper relationships with clients provide lower-cost funding. When it comes to clients that have an earnings credit rate (ECR) account, banks can offer lower interest rates on a separate interest-bearing account than they can for clients without an ECR account. In general, clients that receive higher earnings credits to offset fees are more likely to accept lower interest rates on their deposits. Clients that have a primary banking relationship with a financial institution yield a return on equity that is roughly 20 percentage points higher than clients with a lending-only relationship. When setting prices, banks should consider transaction banking fees as part of the overall client relationship, as clients’ desire to offset these fees with ECRs has increased banks’ operational deposits. Effective pricing requires balancing the client’s sensitivity to both fees and rates to maximize the benefits of earnings credits and operational deposits.
Price sensitivity varies
Banks need client-specific strategies to accomplish the dual goals of retaining deposit balances and improving net interest margins. Price sensitivity analytics can help banks strike the right balance. McKinsey’s commercial deposits analytics team reviewed more than $1 trillion in commercial deposit balances, looking into how they fluctuated in scenarios with rising and falling rates. The team ran analyses to identify varying degrees of price sensitivity across microsegments of clients. The finding: for a typical bank, the balances most at risk of leaving the institution are held by the roughly 20 percent of customers with an interest rate 100 to 150 basis points (bps) lower than the market rate. Interestingly, deposit outflows increase again for clients with significantly higher rates than average, as these clients are very focused on shopping around for the best rates. Banks should consider using tailored strategies to account for price-sensitivity nuances when adjusting portfolio rates.
Customers’ rates on bank deposits might come down as Fed rates decline, but not for everyone. About two-fifths of deposits are earning less than 100 bps in interest, as banks reacted to the latest rising rates cycle with different actions for different clients. Some of these clients might request higher rates in the future, despite falling market rates. In some cases, banks are paying depositors higher rates than they need to. For one bank we studied, these clients represented about 20 percent of total balances. Banks that can identify the types of customers that would likely stay with the institution even if their rates went down slightly, relative to market averages, will be able to reduce funding costs without sacrificing significant balances.
Industry differences
Examining industry differences in the interest rates depositors get from banks, companies in sectors including education, professional services, public administration, and utilities earn lower-than-average rates. On the other hand, businesses in finance, retail, and manufacturing are getting above-average rates. Certain sectors, such as education and professional services, have lower loan-to-deposit ratios and can deliver balances while requiring less than other industries in terms of lending commitments. Long-term success in commercial deposits will come from balancing the right markets, products, and client segments.
The environment for commercial deposits for the remainder of this year is expected to provide opportunities for deposits-driven growth. Banks will need to use client-specific repricing strategies and account for clients’ price sensitivity to succeed for years to come.
Szilard Buksa is a partner in McKinsey’s Dallas office; Manthan Pakhawala is a research science analyst in the Atlanta office, where Ryan Cope is a senior asset leader; and Vanathi Ambigapathi is an asset leader in the Boston office.
The authors wish to thank Bolivar Rojas, Maikael Mora, Pavel Baltabaev, Peter Noteboom, and Victor Varela for their contributions to this article.
This article was edited by Jana Zabkova, a senior editor in the New York office.
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