Deposit rates have been at historic lows for several years. The Federal Reserve has raised their target federal funds rate a few times, causing credit union managers to wonder, “Should we raise our deposit rates?” There are many reasons a credit union may feel pressure to raise deposit rates. Being able to identify valid reasons is essential to proper credit union management. Deposit rate changes should center around balance sheet management, credit union profitability, and continued benefits to the members. Here are some reasons a credit union may feel pressure to raise deposit rates, along with a discussion of items to consider:
Board members are hearing that short-term rates are rising. They want to be sure they are providing the greatest benefit to the members of the credit union, and many times they themselves are large depositors. It is important for the board to understand how the profitability of the credit union is crucial to its long-term viability. Net interest margins have been compressed for quite some time and loan rates have barely budged. Let the net interest margin breathe before compressing it. If the credit union is making some money and the net interest margin is healthy, then a more in-depth discussion on raising rates for the benefit of ALL members could be considered.
Short-Term Rates Are Rising
A rise in the federal funds rate and prime rate does not necessarily mean there is a need to raise deposit rates. While historically there has been strong correlation between the federal funds rate and deposit rates, there has usually been a significant lag in time before deposit rates have risen. Also, many financial institutions are flush with deposits. Therefore, deposit rates may not be expected to react as they have historically.
Many credit unions are not lucky enough to be funding loans so quickly that they need additional liquidity. However, there are some credit unions out there with this issue. Raising deposit rates to fund loan growth is usually more expensive than other methods of increasing liquidity when considering the total overall cost. The deposit rate is raised on the whole deposit type, even though many members are not looking for a higher rate. The credit union may be paying a lower rate than borrowing, but it does pay it on a lot more money along with far less flexibility on timing and term.
Through this latest financial crisis, we have seen many examples of credit unions adjusting their deposit rates and then finding out it didn’t have the anticipated effect. Deposit accounts are appearing to be less and less rate sensitive, and an increase in deposit rates may not provide the liquidity that was anticipated. Additionally, if deposits increase due to a rate change, then the money is most likely rate sensitive and does not contribute to the core deposits of the credit union.
Benefit to Members
When a credit union is profitable and has a strong net worth, the philosophy is to use the profitability to benefit the members. Is an increase in deposit rates what members want most? As mentioned earlier, deposit accounts are becoming less rate sensitive. Credit unions provide more services than just a holding place for their members’ money. Many members are with the credit union for convenience and additional services, not because of the deposit rate. For example, I currently have no idea what rate my primary credit union is paying on deposits or if they are even competitive. I do, however, know how competitive their loan rates are, even though I only have deposits and no loans there. It is important to know what the members want. A quick survey that highlights the priority of additional services and rate increases can help optimize credit union resources. Also, the increased deposits that can come from adding services will contribute to the core membership of the credit union and will typically be less rate sensitive.
Stop Money from Leaving
One of the first things to consider is whether it would be detrimental for some money to leave the credit union, especially the most rate-sensitive money. Many credit unions have seen large increases in deposits without a commensurate increase in loans. If there are excess deposits that cannot be turned into loans in the foreseeable future—and particularly if earnings and net worth are struggling—then it may be beneficial to allow the most rate-sensitive money to leave the credit union. Not increasing deposit rates, in this situation, provides a good opportunity to find out if and how much of the money is most rate sensitive.
Before raising the deposit rate to stop money from leaving the credit union, it is important to be confident that the money would actually leave. Surveys and knowledge of the membership base may show that members really do expect and want an increased deposit rate. It is also imperative that the credit union be aware of competitors’ rates and external pressure for that money to leave. But don’t fall victim to raising deposit rates just because a competitor did. At Mark H. Smith, Inc., we have access to competitors’ rates in your area, and if you would like more information, please contact us.
After consideration of the above–
If the decision to increase deposit rates has been made, then trying to only raise rates for the members who really want it should become the focus. A good segmentation strategy with money market accounts and tiers should be considered if not already in place. With rates still very low, this is the best time to implement a segmentation strategy. A good segmentation strategy can also allow for the members to choose between additional services or an increased deposit rate. For more information on segmentation strategies, please see Mark H. Smith’s article, Segmentation Strategies-Still a Good Tool To Manage Cost Of Funds.
To address pressure to increase deposit rates, a compromise may need to be developed. One option may be a CD special to provide an increased deposit rate to those who are seeking it and to provide more time-specific liquidity. Another option is a one-time special dividend. It provides financial benefit to members while controlling the impact to the balance sheet. A one-time dividend does not come with the same pressure to continue to pay the higher deposit rate into the future. It alleviates the possibility of more rate-sensitive money coming into the credit union when it is not needed. Additionally, a special rebate can be paid out on loans. This will reward the members with loans rather than deposits, which can be beneficial if loan growth is more important than deposit growth.
There are many things to consider when deciding whether to raise deposit rates. Where that pressure comes from and assessing the effects of raising deposit rates should be at the forefront of the decision-making process. There are many other benefits to members or ways to raise liquidity that are possibly more valuable to the credit union and its members.