The COVID-19 pandemic may be the most serious challenge to financial institutions in nearly a century. At the beginning of the COVID-19 crisis, loan loss reserves at the six largest banks in the U.S. went past $25 billion in the first quarter alone. In an effort to triage the economic fallout, the Federal Reserve Bank opened the Main Street Lending Program and the Paycheck Protection Program (PPP).¹

In this Q&A, experts from across S&P Global Market Intelligence, alongside esteemed guest speakers from the University of Chicago and Novantas, examine the implications of the Fed’s central bank’s policies, with special attention to robust interest rate and banking data, and insights on potential policy shifts to spur economic recovery.

The current rate environment

Kimberly Myszkewicz, Senior Product Manager, S&P Global Market Intelligence (Moderator): We've had a prolonged 0% interest rate policy, and rates are lower than they've ever been. When thinking about the historical rate environment, how does our current environment compare to the Great Recession?

Nathan Stovall, Principal Analyst, S&P Global Market Intelligence: While we definitely have a lot of comparisons to the Great Recession, there are definitely some things that are different. Fed funds is at the zero bound, but the 10-year treasury and the long end of the curve is lower than it's ever been by quite a long shot.

Also different are the actions that the government has announced to try to mitigate the blow of the coronavirus, versus the Fed actions. We've been saying the Fed did pretty much everything they did from '07 to '09 in the first few weeks of April, where this time we've had unprecedented stimulus.

While there are all kinds of differences, it's the most comparable period we have to look at. If you look at what happened to deposit costs the last time Fed funds went to zero— the six months ending in the fourth quarter of 2008 — versus the first 6 months of this year: If you look at the decline in Fed funds over that six-month period, they're nearly identical. 158 basis points in the last six months of '08, 159 basis points in the first six months of this year.

Yet, when you look at the change in rates that banks have offered to customers — and by that we're talking about deposit betas, or what percentage of change in rate has passed on to customers — banks have not been able to decrease that rate as quickly as they did in '08. When we talk about betas in a tightening cycle, you want to see them low. When you're going down, you want to see them high, so banks can lower their funding costs. This year, the beta has been about 31% compared to 39% in '08.

And a lot of the reasons for that is why these cycles are different. You've seen things like really strong deposit growth that you’d think would have given banks a little bit more latitude to lower more quickly. But it is interesting that thus far, even when you've seen rates decline by about as much and you've seen an overall level of rates on the long end of the curve, you haven't seen deposit costs decline quite as quickly.

Brad Resnick, Solutions Principal, Novantas^*: As much as the Fed response was pretty similar in how much it cut, the actual response by financial institutions has been pretty different. One of the fundamental differences here is the level of stimulus, the level of surge deposits that is on book now.  The uncertainty, generally, is how long it's going to stay and how much more might come in the future. So there's a lot of extra variables out there today that, I think, institutions are dealing with versus back in 2008.

One of the things that I wanted to address here is how to frame up how you think about the rate environment, what type of metrics and what type of analytics are critical in this environment. What I wanted to talk about today is what we refer to here as flow of funds. And what we noticed is, banks, more and more, have been diving into customer-level balance change and flow of funds. And what we mean by that is, as the rate environment around you changes, how do your customers' behaviors move with that? So both changes that are created by your own institution or changes that are potentially created by the marketplace by geography, by type of institution — what's really happening, and how are your customers reacting?

When you look at balances moving from a starting point to ending point, how much of that balance movement is due to external influences like new acquisition and attrition behavior? And how much of that is due to internal movement, potentially from product to product? A good example of that today is how many customers are moving money from term accounts to liquid accounts in this environment. We've seen a substantial remixing into the liquid environment today.

One of the things that we highly recommend is to make sure you have a framework and analytics to track how that customer behavior is shifting to recognize your opportunities to either lower rate or recognize opportunities potentially to grab acquisition if you increase rate.

The other piece I wanted to touch on briefly here is what we refer to as the marginal cost of funds. And what we mean here is, if you take an example where you start with $100 million in a money market portfolio and you go to launch an acquisition campaign. That campaign generates about $10 million in new money. But you paid about 1.25% to get that new money versus your base rate, which maybe was at 0.25% beforehand. So when you think about that campaign, you're thinking, I'm paying 1.25% to generate $10 million in new money.

But the reality is, there's a second bucket there. And that second bucket represents cannibalization, or dollars that moved – that were already on book, but now have taken advantage of this new offer. So part of your existing $100 million is also jumping into that new rate. And so what's happening here is the cost of your campaign is not only paying 1.25% for the $10 million of new money, but it's the difference in rate from the 0.25% to 1.25% of the $10 million that cannibalized into it. So when you load in the full cost of that campaign, what you're really thinking about here is a cost of about 2.43% to run that 1.25% rate. And so, obviously, that is something you want to factor in, in this rate environment, as people are looking to lower cost. Any promotion you run has a significant chance of potential cannibalization if your book is currently paying a low rate to your standard product.