One of the fringe benefits of having a toddler son is that I get to watch a lot of children’s programming.  Elmo, Mickey, Curious George: they feel like close personal friends.

One of the chief tenets of today’s children’s programming is the notion that it’s OK to be different.  No matter what you look like, we’re all the same inside, right?  And even if someone looks different or talks differently, he/she deserves respect.  It got me thinking.  About banking.  On a Saturday morning.  I’m that kind of dad.

Non-interest income will go down this summer (Thanks, Fed!).  Loan losses look set to continue for some time.  Operating expenses have been cut to the bone while the growing cost of compliance lurks.  And yet this industry continues to overpay for deposit dollars. 

So here’s my thought: What if we applied this concept — that it’s OK to be different — to our pricing? 

Due to the consolidation of the industry during the economic turmoil, numerous banks have found themselves in brand new markets.  And still, no matter where a customer might be or what the local market is like, many institutions continue to price the same way for all markets.  Certainly, it’s easier to have a centralized pricing strategy.  For one, ALCO meetings are shorter.  Likewise, marketing doesn’t have the headaches of managing different Web sites and rate sheets for the various markets.  Additionally, IT doesn’t need to implement multiple product codes for the same product.   Of course, due to the relatively diffuse nature of lending, most loan rates don’t really change from market to market, at least not enough to justify the additional time and expense.  But for deposits, it can be crucial.

Marcus Rothaar and Paul Leavell have in this publication written previously about ways to moderate your deposit rates.  (I would say “slash deposit rates,” but someone told me that “slash” is too extreme.)  Regional pricing follows the same theme.  If your deposit strategy takes competition into account (you DO have a deposit strategy, don’t you?), then you have to take regional differences into account as well.

Let me describe an institution, which we’ll call 1^st National Bank of Elmo.  This institution has branches in two distinct markets, over two hours’ drive from each other, each with a unique demographic profile.  The first market is in Elmo, a small town comprising mostly older depositors.  The other is an urban market in the city of Zoe consisting primarily of upscale, young professionals.  Each market has different competitors, although there is a little overlap.

In the small town of Elmo, the bank is one of two dominant institutions, controlling the lion’s share of retail deposits, held primarily in certificates from elderly consumers.  In Zoe, it is one of five equal competitors with 20 percent of the market.  Zoe is a growing market with significant opportunity; Elmo is not growing, and opportunities to increase market share are limited.

In which market should the bank be more aggressive?

If you said Zoe, you’re right.

Now, this all goes back to microeconomics (ECON 101, assuming you didn’t sleep through that class in college) and the theory of market structure.

All markets range in levels of competition, from monopoly (where there is only one seller) to perfect competition (where there is an infinite number of sellers).  Price is highly correlated with this market structure: if an institution works within a monopoly, it can charge any price it wishes; if it works within perfect competition, its price is purely at the discretion of the buyer.

Now let’s put that into the perspective of my fictional institution, 1^st NB of E.  Elmo is a classic oligopoly.  There are two institutions that control the vast majority of the market’s deposits.  Therefore, they can set price (like a cartel) as low as they wish.  There is little chance for another institution to enter the market, since it takes time and money to build a location, and deposits are still very much location-specific.  In fact, even if the other institution chooses not to engage in price-setting, there is little risk to losing market share. 

As an example, consider the airlines.  The legacy airlines have raised fees and slashed services, yet they have not significantly lost market share.  I need to get from Chicago to LA as quickly as possible: I can choose United or American, and I will pay whatever price I have to.   It would take an extreme fare for me to drive to Milwaukee to catch a flight, or instead take the train, or even drive all the way with my copy of “The Wealth of Nations” securely strapped into the child car seat.

You can consider a political example as well:

• In the US, we have two choices politically.  On average, over the past 14 national elections, 49 percent of eligible voters have voted, meaning that over half of all eligible American voters choose not to participate. 
• In Canada, on the other hand, with at least three major parties, 67 percent of eligible voters have voted over the same period of time. 
• France has an unlimited number of parties (and a proportional system which rewards smaller parties); in 2007, 84 percent of eligible voters participated. 

In other words, complacency declines with more choices, and it is no different for the banking industry.  1^st NB of E could lower its CD rates in Elmo significantly and see practically no runoff, due to the latent complacency of the customer base.

On the flipside, in Zoe, where the market is more competitive, deposit rates are likely to be higher.  Customers are more likely to be engaged in the business of managing their deposits in a competitive market.  Banks are more aggressive against one another, focused on capturing the marginal improvement in market share.

Interestingly, this difference in competition trumps demographics in predicting rate sensitivity.  Elmo is a much older market, one that we would normally consider highly rate sensitive, yet the younger market in Zoe is where slight deviations from the competition lead to inflows or outflows.

So what should 1^st NB of E do?  It should examine its rates compared to the competition in Zoe, and then begin to lower its rates in Elmo.  Elmo’s rates might be 25 to 50 basis points lower than Zoe’s.  Consider the impact that could have on funding costs!

As you assess your own institution, evaluate the regions and markets where you have a presence.  How competitive are they, relatively speaking, and where are you priced in each market?  Knowing that it’s OK to be different, could you price regionally?

 

For more information on regional pricing, attend my Webinar:

Title: Pricing Regionally: Optimizing Profits Through Diversity

Date: July 22, 2010

Time: 1:00 – 2:00 pm central

Price: $149

Link to Register:  http://registration.raddon.com/step4.asp?2857

| Comments (RSS) |