By: Chris Joy, Principal, Advisors Plus Consulting
We live in interesting times in the financial world, with “disruption” being a key word that can be applied to the experiences of the last four years. Many factors affecting financial services, from technology to economics to consumer behavior, have changed dramatically. As this year is already providing similar dynamics for financial institutions, below are five topics that warrant a closer look as the year progresses.
Protecting Deposits
Deposit costs have increased significantly following the high-profile bank failures of Silicon Valley and Signature Banks in early 2023. Given the Federal Reserve’s increase in the Fed Funds Rate, it is not hard to find certificate and money market rates in the 5% range.
The Federal Reserve’s Bank Term Funding Program (BTFP), created to assist funding needs arising from liquidity challenges, ends this month. This may put some pressure on growing core deposits and securing alternate sources of funding. Additionally, the speed of money movement needs to be considered, as some depositors may search and move quickly for higher returns.
It will be critical for financial institutions to promote competitive rate structures that meet their deposit goals, minimize accountholder attrition and provide avenues for growth. It is a fair expectation that the cost of deposits will remain elevated, even if projections for lower Fed Funds and market rates hold true.
Lending Products That Gain Momentum
If market rates and related indexes begin to fall (although the questions seem to be “when?” and “how much?” rather than “if?”), some originations might be primed to grow above 2023 levels.
- Home Equity Lines of Credit (HELOC) – Rich introductory promotions, declining APRs and consumer need to consolidate debt at lower rates make this an attractive source of originations and usage.
- Mortgages – The thaw begins if rates fall under 6% for both refinancing and existing home sales after bottoming out in the latter half of 2023.
- Small Business Credit Cards/Lines of Credit – More and more startups and small businesses look to flexible credit products to provide means to pay suppliers, buy inventory and provide working capital.
Delinquency and Losses: Remnants of COVID-19 or Systemic?
Retail lenders are closely evaluating the root causes behind the steady increases in delinquency and credit losses. Some commonalities have started to appear – sub-prime credit, lower incomes, younger adults, high debt levels and recent originations appear to be playing outsized roles in the current picture of risk. Additionally, long-anticipated risks in commercial real estate are starting to manifest. All of this activity is occurring during a sustained period of low unemployment.
If elevated levels of risk start to decline after June of 2024, it may be because the higher risk levels were “delayed” effects of prior COVID-19 support efforts. During the pandemic, individuals had more cash flow with government-initiated supports, and inflation had not yet fully affected daily expenses. However, if risk remains elevated beyond June 2024 or if unemployment jumps notably, one can probably assume that the higher levels of risk are systemic and likely to continue for the remainder of the year.
Regardless of any higher risk duration, recovery pools should be at the largest levels in years. Diligent efforts to maximize recoveries with proper placement should provide some cushion to any burgeoning losses.
Does Consumer Underwriting Require More of a Cash Flow Approach?
One thing that became clear months into the pandemic is that credit scores became somewhat opaque as to what they told us about applicants. Yes, credit scores still provided separation of risk, but the basis of the score is credit bureau data. The credit bureau data did not fully account for the explosion of Buy Now, Pay Later (BNPL) purchasing and the forbearance or “on-ramp” associated with student loans. BNPL data is mostly unreported to the credit bureaus, and student loan borrowers are not required to make payments (or be reported delinquent) until October 2024. Essentially, aggregate debt levels and ability to pay were less than transparent.
These scenarios call for more information to be evaluated in scorecards and underwriting processes. Assets in time deposits, IRAs and 401ks can indicate levels of security backstopping income. Permissioned views of checking account activity can reveal rent payment history, overdraft activity, BNPL borrowing and penalty fee incidence.
Taken as a whole, integrating more information depth when underwriting and approving credit extensions can provide greater insight into an individual’s cash flow to meet debt obligations.
The Rise of Open Banking
In October 2023, the Consumer Financial Protection Bureau (CFPB) released its proposed rule addressing Section 1033 of the 14-year-old Dodd-Frank legislation. The intended purpose of the proposal is to increase competition to benefit consumers. The proposal requires the secure, permissioned transmission of accountholder data. It identifies how standardized APIs can send accountholder information, terms, fees and transaction history to fintechs and aggregators upon accountholder request.
Benefits to consumers can be numerous – highly personalized rewards, incentives, financing, investing and financial advice are obvious use cases. However, so are offers to accountholders for better fees, better features and lower rates based on their personal checking, debit and credit use. Financial institutions must prepare for how they intend to play in this marketplace by going on offense to acquire checking, deposit and credit card accounts where they create an attractive advantage. The strategy also includes playing defense as other financial institutions attempt to do the same.
Expectations for finalization of the proposal are late 2024, with staggered requirement dates based on the asset size of the financial institution.
There is no way to know for sure how the rest of the year will play out, but it is clear that it’s not going to be dull. From protecting deposits and understanding delinquency to leveraging a wider range of lending products, embracing consumer-centric underwriting approaches, and preparing for the rise of open banking, financial institutions must navigate these shifts to position themselves for long-term success.
Christopher Joy is a Principal Consultant with the Advisors Plus credit card practice. He advises financial institutions on a wide range of contemporary issues involving the credit card business. Chris has earned an industry-wide reputation for creating balanced, competitive and effective credit card portfolio solutions for his clients. His decades of experience, coupled with in-depth knowledge of current markets, provide valuable insights when assisting clients in the highly competitive credit card marketplace.
Before joining Advisors Plus, Chris served as a Vice President at National City Bank (now PNC Bank) with portfolio management, marketing information and financial management responsibilities. He also served as a financial analyst with Bank One (now Chase). Chris holds a BBA in Business Administration from Ohio University. A regular speaker at industry events, he also served on the faculty of the CUES School of Payments.
