Bruno Colmant, Kasper Peters, Joeri Gussé, Wouter Vanderheere · Bruno Colmant, Kasper Peters,...

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Retail deposits – Prepare for a bumpy ride

Why banks must get better at profiling their clients' savings behavior and analyzing deposit elasticity

Bruno Colmant, Kasper Peters, Joeri Gussé, Wouter Vanderheere

Key messages

> Deposits form the cornerstone of the economy. EU households hold an impressive EUR 8.5 trillion in deposits – one-third of all financial wealth. Despite real returns as low as -6% in the last three years in some countries, the flight to low-risk deposits continues

> Banks are dealing with a whole new ball game compared to five years ago. To achieve success in the area of deposits and savings, they need to strike a balance between deposit stability, bank profitability and client retention

> The pricing of deposits in the current low-rate environment is a major concern for all retail banks. Two factors have a strong influence on pricing at a country level: the funding gap (as expressed by the loan-to-deposit ratio) and the strength of the sovereign state

> Deposits used to be cheaper than interbank lending, but things changed in 2009. The financial crisis and the introduction of liquidity targets under Basel III, which favored retail deposits, triggered a major shift from the asset to the liability side. Banks started fighting for deposits; since 2012 they have probably been overpaying on them

> Since the financial crisis, governments have strengthened their grip on the deposit base. Some EU countries have installed price and export control mechanisms and are determining deposit allocation. Since Cyprus, it is clear that the government also determines the fate of deposits in the case of bank wind-downs

> Based on its project work with retail banks in Europe, Roland Berger has defined two new

pillars upon which banks can develop their deposit and savings business: profiling client savings behavior and modeling the elasticity of savings volumes

> Banks need to understand the flow of savings between their own savings products – i.e. cannibalization – and from their products to competitors' products. This will help them make their pricing more granular, target their loyalty schemes better, optimize their marketing campaigns and identify gaps in their range of savings products

> Sooner or later interest rates will go up. But whenever this happens, we are in for a bumpy ride in the area of savings. The wealth accumulated in deposits represents a risk to financial stability. Deposit flows are inevitable in the coming months. Their direction will largely determine client retention, financial stability and the profitability of banks

Cover photo: Hartmut Naegele / laif

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Introduction

Savings represent one of the fundamental pillars of economic and financial life. Our system is built on the accumulation of savings and their circulation or transfer to investments, with banks acting as intermediaries. The financial crisis and new regulation such as Basel III have pushed savings center stage in the debate. Deposits – including sight deposits, time deposits and deposits redeemable at notice – have become the central pawn in the complex financial game played by households, banks and governments. Households want to protect their savings. This has led to a flight to certainty by consumers. At the same time, governments are using fiscal measures to try to get their hands on these savings to finance their own debt, preferably at favorable rates. They have also endeavored to socialize the risk of bank runs by creating a European deposit guarantee scheme, but implementation of the scheme proves very difficult. Banks are struggling to find the right balance between deposit stability, bank profitability and client retention.

4 Retail deposits – Prepare for a bumpy ride

1. Retail deposits have become synonymous with stability

Deposits are a cornerstone of our economic system. The average EU household saves about 11% of its disposable income (with large differences between regions). One-third of this is invested in deposit products held at banks, such as term accounts or savings accounts. This accounts today for a total of EUR ~8.5 trillion - one-third of all financial wealth. This is an essential factor in financing the economic activities of individuals, businesses and governments. The proportion of deposits has historically remained relatively stable at about 1/3 of households' financial assets and deposit growth is mainly correlated with economic growth.

1.1 Wealth continues to flee to deposits despite negative real returns The recent crisis years have seriously impacted savings in the EU. Households have started to save more and take on less debt. In most EU countries, deposits have grown by at least 30% since 2003. In some, such as Sweden, they have more than doubled. Households prefer the certainty and liquidity of bank deposits to spending, or risky investments in equity or funds.

Figure 1: Correlation between change in deposit volume and nominal GDP, EU-17 [%]

2007

2001

2006

1996

20042005

20022003

epos

it vo

lum

e gr

owth

10%

9%

8%

7%

6%

5%

4%

3%

Source: Eurostat – 2008 and 2009 excluded as outliers

Change in GDP at current prices

6.0%5.0%4.0%3.0%0.0% 2.5% 3.5% 4.5% 5.5%

2000

19991998

1997

20102011

De

0%

1%

3%

2%

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This growth in deposits is all the more remarkable as deposits currently offer negative returns in real terms in many countries, including France, Germany, Belgium, Italy and the UK. In some others, such as Spain, the Netherlands and France, interest rates on deposits do little more than compensate for inflation.

Figure 2: Growth of deposits in selected EU countries [indexed: 2003 = 100]

160

180

200

220

240 Sweden

SpainBelgiumDenmark

N th l d United Kingdom

Source: Eurostat

80

100

120

140

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Portugal

Netherlands

FranceItaly

United KingdomGermany

Figure 3: Real return of deposits in selected EU countries, excluding tax impact[%]

-4

-2

0

2

4

6 Cumulative 2010-2012

-6.0%

-2.1%

-4.5%

-1.5%ItalyUK

GermanyBelgium

2013201220112010200920082007

Source: Eurostat; ECB

0.0%

-0.7%

+2.1%

-2-101234

The Netherlands

FranceSpain

2013201220112010200920082007


1.2 Deposits are the main source of funding for EU banks The financial crisis and the regulation that came hot on its heels have forced banks to re-embrace their traditional core business model, in which deposits play a central role. Deposits are generally the primary source of funding for banks in Europe, representing over 50% of their liabilities. Before the crisis, interbank lending was growing in significance. More recently, however, regulators have actively encouraged a shift back to deposits, the traditional source of funding. Under the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) of Basel III, banks are required to demonstrate the stability of their deposits, leveraging the full potential of deposits in calculating these ratios. In the revised LCR, for example, the run-off of retail deposits is used to calculate the total net cash outflows in a period of stress. Stable deposits receive a minimum run-off factor of 3%. Stable deposits are deposits fully covered by an effective deposit insurance scheme or where depositors have other established relationships with the bank that make deposit withdrawal unlikely. As a result, banks' dependency on interbanking funding fell from 19% in 2007 to 12.4% in 2012. This has been partially compensated by an increase in retail deposits (deposits held by non-Monetary Financial Institutions, excluding deposits by central government) of EUR 2,393 billion in the same period.

1.3 Financial and public system differences explain the variety in deposit volumes and structures across countries

Deposits are growing across the EU. However, their popularity varies from country to country. In general, Eastern and Southern European households invest more than 40% of their financial assets in deposits, while Northern European households invest less than 20%.

Figure 4: Breakdown of the financial assets of households in selected EU countries in 2011 [EUR billion; %]

4,02895118,527310 7701,8325,1623,464100%

6324,7152823821,688150263

Savings / capita[EUR '000]

23 14 37 36 7 58 68 56 86 62 57 82 110 81 113

Source: ECB; Eurostat

France

29%

Belgium

30%

EU17

33%

Ireland

37%

Sweden

18%

NL

21%

UK

28%

Italy

29%

DK

AVG:35%

18%

Germany

37%

Poland

39%

Portugal

40%

Spain

45%

Czech

48%

Greece

73%

Securities other than sharesLoansCash

Other accounts receivable/payable Insurance technical reservesShares and other equity Deposits

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To a large extent, the level of disposable income determines the proportion of deposits in the savings portfolio: the higher the level of disposable income, the lower the share of deposits. Europeans with a larger financial buffer invest more in advanced investment products, such as insurance products, equity and debt securities or funds. The average Swedish household, for example, had almost EUR 22,000 in disposable income in 2011 and held a mere 18% of their financial assets in deposits. The Czechs, on the other hand, had just EUR 14,000 on average and held almost half of their financial assets in deposits.

A second important factor in the level of savings in a country is the country's pension system. The more you have to save for your own pension, the less likely you are to invest in deposit products. Essentially, the two forms of saving are complementary given their very different maturity horizons. The picture differs from country to country with regard to specific deposit products, too. In countries with special fiscal exemption regimes – France, Belgium and the Netherlands, for example – deposits redeemable at notice are the most popular type of deposit.

Figure 5: Inverse correlation between real adjusted gross disposable income1) and the share of deposits in the savings portfolio in selected EU countries in 2011

25

30

35

40

45

50

55

60

PolandPortugalSlovenia

Slovakia

Finland

United Kingdom

Germany

Hungary

sits

in to

tal f

inan

cial

ass

ets

Norway

Czech Republic

Ireland

Spain

FranceItalyBelgium

1) "Real adjusted gross disposable income" = gross disposable income taking into account the average purchasing power of the currency per country

10

15

20

25

22,000 24,000 26,00020,00016,000 18,00010,000 28,00012,000 14,000

Sweden

gNetherlands

Denmark% d

epos


Real adjusted gross disposable income (EUR per capita)

Figure 6: Breakdown of household deposits in selected EU countries in January 2013 [%, EUR million]

76% 74%

51%34% 32%

7% 13%

25%

19% 15% 78%58%

16% 13%24%

47% 53%

21%42%

737100%

902 132299 387 1,8111,191

Sight deposits


34% 32%

GermanyFrance0%

ItalyNLBelgium0%

Portugal Spain

Sight deposits

Deposits redeemable at noticeDeposits with agreed maturity


2. Governments are increasingly controlling the deposit base

Governments in the EU are increasingly exerting direct control over deposits. For governments, the stakes are high. In the first place, deposits help stabilize the funding structures of banks and so reduce the risk of governments having to bail them out. Second, deposits are a prime source of financing for sovereign debt. Third, pending a decision about the European deposit guarantee scheme, most national governments themselves guarantee deposits up to EUR 100,000. Affluent clients are therefore spreading their deposits across different banks. Finally, deposits are needed to finance the real economy. To protect their stake in deposits, national governments have introduced regulatory restrictions at three levels. First, some national governments like Spain or Belgium have put in place price controls on deposits. Second, there are also several cases of export control on deposits. Cyprus is of course the main but not the only example. Third, more and more EU countries are reinforcing state control over the allocation of deposits. France has a strong tradition of state intervention in savings via the Livret A, but Belgium introduced in 2013 a new kind of savings products, whereby deposits are earmarked for specific purposes. Data on sovereign debt reveals also that governments are increasingly using national deposit bases to fund national debt. This phenomenon – known as "financial oppression" when combined with low interest rates – shows how governments are attempting to nationalize their deposit base in order to finance their own debt. These measures are causing a fragmentation of the European financial market, which will continue as long as there is no European banking union. What this amounts to is essentially a nationalization of the deposit base: governments want to be able to decide where the deposit capital is used.

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3. Banks must react to the structural shifts in the savings domain

3.1 Deposits have become the most expensive source of funding Prior to 2009, deposits were considerably cheaper than interbank lending as a source of financing for banks. Today, largely due to the financial crisis, the opposite is true. There are a number of reasons why banks are prepared to pay more for deposits now than they were in the past. Deposits are a more stable form of funding than interbank loans. They also receive favorable treatment under Basel III. So offering a margin above interbank rates such as the Euribor makes eminent sense for banks. Since 2012, banks appear to be overpaying on deposits compared to other sources of funding. The long-term refinancing operations (LTRO) program introduced by the European Central Bank has been a major factor in reducing interbank rates, but deposit rates have failed to follow suit. This suggests that a psychological threshold may exist with regard to the rates of return offered to customers – one that banks are unwilling to break.

The extent to which banks overpay on deposits varies from country to country. Italy, Spain and the Netherlands in particular are paying a high margin over and above the twelve-month Euribor rate.

Figure 7: Comparison of the cost of different sources of funding at EU level [%]

2%

6%

5%

4%

3%

Euribor 12M

Cost of deposits Eurozone

Source: ECB

2%

1%

0%2013201220112010200920082007

LTRO


3.2 A country's funding gap and the strength of the sovereign significantly influence the overall deposit price level

The differences in interest rates currently offered on deposits in various EU countries are huge, ranging from less than 1% to almost 7%. The pricing of deposits is determined by four main factors: the European Central Bank rate, the overall level of competition between banks, the surplus or deficit of deposits in the country, and the strength of the sovereign. These last two drivers are the most important ones. The surplus or deficit of deposits is indicated by the aggregated loan-to-deposit ratio for the country.

The strength of the sovereign is shown by the "credit default swap" on the country in question: where a strong sovereign state exists, banks are more solid and do not need to pay as much on their deposits; the reverse is also true. The combination of these two factors explains why the interest rate in the Netherlands is relatively high, for instance. The Netherlands has a strong sovereign state but banks have a deficit of deposits from which they can grant loans. Belgium, on the other hand, has a high savings rate but its sovereign is weaker than that of the Netherlands.

Figure 8: Comparison of the cost of different sources of funding by country [%]

6%

5%

4%

3%

2%

1%

0%2013201220112010200920082007

LTROEuribor 12M

FranceGermanyBelgium

Source: ECB

2013201220112010200920082007

NetherlandsSpainItaly

LTROEuribor 12M

6%

5%

4%

3%

2%

1%

0%2013201220112010200920082007

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3.3 The center of gravity has shifted from assets to liabilities, but banks have yet to follow suit

Prior to 2009, banks mainly concentrated their efforts on the asset side in the hope of obtaining the highest possible yields. Consequently, much of their customer analysis and modeling expertise using advanced econometric techniques – credit analysis techniques, advanced probability of default models, and so on – had a bias toward assets. By and large banks lack similarly advanced techniques on the liabilities side, specifically in the area of deposits. Very often, they base their pricing and product decisions in deposits on the opinions of product managers. Budgets and annual deposit volume forecasts rely on intuitive calculations rather than solid mathematical models. Unsurprisingly, product management and asset and liabilities management (ALM) departments often have difficulty agreeing upon deposit pricing. That might have been acceptable before the crisis, but it is no longer a viable option. Liabilities are now the determining factor in retail banks' revenues, profits and growth potential.

12

34

56

78

9

Figure 9: Funding gap and sovereign strength as drivers of deposit rates

ESP [2.62]

SV [2.15]SK [1.97]

ROM [6.79]

POR [3.52]

IT [2.24]

HUN [5.58]

CZE [0 94]

CYP [4.08]

BE [1.18]AT [1.65]

Sovereign strength[CDS, %]

FR [2.10]

0

1

-40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60 65

Source: ECB

UK [1.93] NL [2.61]GER [1.42]CZE [0.94][ ]

DEPOSIT SURPLUS SHORTFALL OF DEPOSITS

Funding Gap [%]

"Deposit rate" = interest rate on deposits of up to one year to households and institutions serving households, 2011 average"Funding gap" = based on the loan-to-deposit ratio at country level "CDS" = average for 2011 for country in question[ ] = average deposit price

FIN [2.00]

Figure 10: Shift from the asset to the liability side

PAST SITUATION CURRENT SITUATIONAssets Equity/Liabilities

Easy access to fundingAsset diversification Focus on securing

fundingFlight to high quality

liquid assets

> In the past, funding was easily accessible and banks concentrated their efforts on getting the highest possible return on the asset side

> Econometric models were focused on loans with limited attention for deposits

> At asset side, sovereign domestic debt is favored and risk appetite for risk is low

> Basel III and risk policies push banks to concentrate on the liabilities side

> However, the models related to the stability of deposits and the movements between savings products are still in their infancy

Assets Equity/Liabilities

Source: Roland Berger Strategy Consultants

Banks need to further professionalize their approaches on the liabilities side (deposits, term accounts,…)

products are still in their infancy


4. New pillars for savings strategies

4.1 Three new drivers determine the strategy in savings When it comes to savings, banks are dealing with a whole new ball game compared to just five years ago. In particular, a range of new structural drivers have appeared. First, more than ever banks now need easy access to stable, cheap funding. It is vital that they find levers to control the stability of their deposit base. Asset liability management (ALM) has become a much greater factor in deciding which type of savings products can be promoted or launched. Secondly, savings strategies must take into account government constraints such as price, export or allocation controls. More innovation is needed for banks to differentiate themselves from their competitors. Thirdly, client behavior is more difficult to anticipate now. Banks are experiencing one of the longest periods of low interest rates in their history. At the same time, they are facing a high level of risk aversion in their clients due to volatility caused by the crisis. The deposit guarantee system also means that clients are spreading their savings over more banks than before, which implies that each bank gets a smaller slice of the cake. In response to these drivers, banks need to strike a new balance between deposit stability, bank profitability and client retention.

Figure 11: New drivers of banks' savings strategy

STRATEGIESIN THE

SAVINGSDOMAIN

Financial return for client

Access tofunding

Stability of funding

Cost of D it/g t /

Risk level for client/MIFID

Easy access to stable & cheap funding

Client: best risk-return relation

LOWINTEREST RATE

CRISISVOLATILITY


DOMAINCost ofunding

Price control

Export control

Allocation control

Deposit/guarantee/capital protection

Government constraints

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4.2 Major changes in the savings domain coming sooner rather than later Low interest rates and economic uncertainty are creating deadlock. This favors an unhealthy build-up of short-term deposits. Is there a way out? If interest rates remain low for an extended period – and most analysts predict no major change before 2015 – banks will find themselves under pressure to stop overpaying on deposits. But they will have to tread very carefully with their pricing, at the same time as investing in innovative ways to reward client loyalty. At-risk client segments need to be secured with new loyalty schemes. In a low-interest scenario, some clients will be willing to accept higher risks and returns. Banks will need a clear commercial strategy on how and when to offer alternative products in order to retain the deposit volumes they have accumulated over recent years. Of course, it is possible that interest rates rise sooner than anticipated. This is not entirely unrealistic, especially as far as long-term rates are concerned, as we have seen recently. In this scenario, large outflows of deposits are possible in a very short period, undermining banks' financial stability. As with the low-interest scenario, banks need to have a clear strategy in place for this eventuality.

4.3 Only banks that profile savings behavior and fully understand volume shifts can strike the right balance

Based on its project work with retail banks in Europe, Roland Berger has defined two new pillars upon which banks can develop their deposits and savings business. First, it is essential that banks improve their ability to profile their clients' savings behavior. This profiling is not the same as the classic client segments based on assets under management. Instead, it is based on actual observable client activity. It enables banks to predict a customer's propensity to move to another bank, or accept an offer for an alternative savings or investment product.

The second pillar for banks is modeling the elasticity of savings volumes. The model used should quantify the relationship between changes in the volume of deposits or other products and factors determining the inflow and outflow of savings products. It must look at both other products offered by the bank and products offered by its competitors. The model should be based on an ongoing circular process, enabling the bank to forecast the internal flows between its own savings products and the external flows to competitors' products or alternative investments.


Various factors influence these flows, including the gap between the bank's interest rate and that of its competitors, market interest rates, fiscal policy, confidence in financial institutions (expressed by the credit default swap) and GDP growth.

Figure 13: Customer elasticity analysis

38%

31%

24%

20%

27%

20%

31%

25%

26%

18%

42%

23%

22%

13% DEPOSIT VOLUME VARIATION

DEPOSIT PRICE VARIATION

+

+

–

Bank A high elasticity

Bank Blow elasticity


Term Account D

25%

Term Account C

15%

Savings account B

31%

Savings account A

Very low elasticity clientsLow elasticity clients

Medium elasticity clientsHigh elasticity clients

–

Figure 12: Overview of internal and external savings flows

Demand deposits Bonds, shares

Termdeposits Funds, Insurance products

INTERNAL FLOWS


Competition Alternative investments (e.g. real estate)

EXTERNAL FLOWS

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Profiling client savings behavior and modeling the elasticity of savings volumes can help banks to: > Price their products on the basis of the elasticity of specific target segments

and avoid overpaying

> Offer new loyalty schemes to their best clients, helping stabilize their deposit base and retain clients

> Proactively suggest "next-best products" through marketing, thereby controlling deposit flows and retaining savings they have accumulated

> Offer innovative products with new risk/return balances, in so doing optimizing profitability from their fee business

Building on the two new pillars also helps banks create a more professional asset liability management (ALM) strategy. It improves their calculations with regard to the Basel III liquidity requirements, deposit stability and the cost of funding. Budget forecasts become more detailed and reliable. Regulators across Europe are likely to demand such approaches to deposit and other saving products in the near future.

Figure 14: New business and ALM strategies

BUSINESS STRATEGY

> Pricing deposit

> Loyalty incentives

> Commercial campaigns

> Product portfolio review

ALM STRATEGY

> Liquidity targets

> Stability

> Cost of funding

PROFILING OF CLIENT SAVINGS BEHAVIOR

MODELING OF ELASTICITY OF


SAVINGS VOLUME


5. Case study

A new savings strategy for a Belgian retail bank Market and client context The Belgian market comprises approximately EUR 400 billion in deposits by households and companies. It is dominated by four large banks. However, tier-two players have been gaining significant market share in recent years. A number of banks used the legal reforms introduced by the government in 2012 as an opportunity to revise their deposit strategy. In 2010-2012, our client had grown its deposit base by more than 10% by means of an aggressive pricing strategy. Approach Working closely with a company specializing in econometrics, we examined our client's historical deposit volumes, pricing strategy and other market data, paying particular attention to factors influencing the inflow and outflow of deposits. By this means we were able to quantify the elasticity of the total deposit base and of each individual savings product. In parallel, we examined the bank's profit and loss model for deposits. Taking the results of this analysis, we then drew up a number of different scenarios. These were based on different assumptions about the client's product positioning and pricing points, as well as competitive and macroeconomic factors.

Figure 15: Approach used in client project

Internal bank data

Products, volumes, prices, campaigns, …

Competitor data

Products, prices, campaigns, …

ECONOMETRIC ANALYSIS

> Identification of factors influencing in- and outflow

> Multivariate

ELASTICITY MODEL

> Price elasticity/ sensitivity per product

> Impact on P&L

SCENARIO-BASED FORECASTING

> Interest rate scenarios

> Volume and P&L forecasts

PRICING OPTIMIZATION

Adapt pricing strategy

PRODUCT PORTFOLIO ALIGNMENT

Launch new products, reposition existing products


GDP, inflation, stock, real estate, …

Macro-economic market data

> Multivariate regression analysis

products

ORGANIZATIONAL INTEGRATION

Change organization governance

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Results The project radically changed the way that the client makes its deposit pricing decisions. In the past, it based these decisions on the opinions of its product managers. Now it takes a more fact-based approach, using robust models to support the process and create a more objective basis for discussions in ALM and pricing committees. The client is pleased with the improvements: "Our pricing is now much more granular – we work at the level of individual base points rather than tens of base points. We also understand the elasticity of our customers much better, so we no longer need to include a 'confidence zone' in our pricing." As a result of the project, the client also changed its product positioning. Certain products clearly had a more loyal customer base than others. With the help of this knowledge, the bank could target their cross-selling better and make more proactive offers.


CONTACTS

Bruno Colmant Partner Roland Berger Strategy Consultants, Brussels Phone: +32 2 6610-324 E-mail: [email protected]

Kasper Peters Principal Roland Berger Strategy Consultants, Brussels Phone: +32 2 6610-324 E-mail: [email protected]

Wouter Vanderheere Consultant Roland Berger Strategy Consultants, Brussels Phone: +32 2 6610-324 E-mail: [email protected]

Joeri Gussé Junior Consultant Roland Berger Strategy Consultants, Brussels Phone: +32 2 6610-324 E-mail: [email protected]

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