We are in the midst of a risk that none of us prepared for or truly anticipated; a “novel” risk. Times like these call for distinctive leadership: simple, clear, to the point, back-to-fundamentals leadership.
A great such leadership paradigm was exemplified by US Navy Vice Admiral James B. Stockdale, a POW during the Vietnam War. Like bank executives today, he had to manage an extreme crisis. His approach was to focus on the facts and be honest about the situation with himself and those he led. His focus was laser-sharp so that he could understand the implications of all the moving parts and plan the right tactical approach. However, in addition to the careful assessment and the tactical actions, true leaders offer hope. Hope that is grounded in facts; not hope for the sake of hope.
In this white paper we describe seven situation assessments for banks (implications & suggested actions) and one leadership approach.
1. Growth Dampening
Implication
Growth will be dampened. Competitive movements will be slowed. It’s a timeout for growth (high, low, or negative). There will be less account mobility, lower attrition, and lower acquisition. Growth in the zero-sum game of regional banking will therefore be mostly “average” for this period.
Suggested action
Time will be available for weaker players to up their competitiveness during the hiatus. Think of how often you said, “I wish the world could freeze for a few weeks so I could work on transforming my franchise”. Admittedly it is hard to focus on long-term strategy in the middle of a crisis, but if a bank’s management team can manage to compartmentalize the tactical day-to-day fight against COVID-19 from the long term strategic realignment, the bank will emerge competitively stronger once the crisis is over and the normal competitive game restarts.
2. Net interest income dislocation
Implication
Net interest income will experience a short-term dislocation followed by a medium-term suppression. Net Interest income impact will depend on whether a bank is more “locked in” with CDs relative to fixed-rate loans. Since the majority of loans and CDs will reprice in a matter of months, we will return to the recent near-zero interest rate environment which especially hurt banks with large portfolios of DDAs, since their low-cost funding advantage diminished.
Suggested action
Update deposit repricing models. The repricing betas will be lower given “implication #1” above, so this might allow banks to more rapidly reprice MMDAs, Savings, and NOW accounts.
3. Bifurcated deposit book
Implication
Customer level deposit dynamics will be highly variable. Deposits will have a bifurcated behavior:
a. Households that see their income decline due to loss of employment, or loss of business revenue will tap into deposits and they will dwindle.
b. Households that do not experience an income hit will see deposits increase because a lot of discretionary spending (restaurants, non-essential retail purchases, vacations) will decline.
c. Businesses affected by social distancing (e.g., restaurants and hospitality overall, retail shops, gyms, etc.) will deplete much of their liquidity as they cover fixed expenses in a period of lower or even zero revenue.
d. Other businesses will increase their revenue and their liquidity (e.g., super-markets, home exercise equipment, gun stores, online retailers, etc.).
Suggested action
Do not panic if some customers deplete their deposits faster. Focus on the ones who seem to be increasing them and make sure they are being served well by your front line (remotely, most likely). On those who deplete deposits, start targeted conversations and see if they would qualify for any HELOC or other credit line or other credit product so they can protect their liquidity. In times of crisis, for psychological reasons, customers are far more amenable to have larger liquidity at the same time as they have larger credit balances outstanding. They are not trying to optimize liquidity but often to maximize it for peace of mind.
4. Fee revenue profile shift
Implication
Fee revenue will change profile. Interchange revenue will increase as consumers reduce cash use and opt for contactless cards and online purchases. On the other hand, ATM fees will go down as cash becomes less attractive and as in-person purchases give way to online. SCDAs should go up as certain consumers fall below minimum balance requirements and also incur more NSF/OD feeds.
Suggested action
Like with #3 above, don’t panic. Do reinforce to customers that they can use their debit cards for online purchases and, if you offer contactless cards, do remind customers about that functionality. If only certain customers have contactless cards, communicate with them only, e.g., by alert on online/mobile banking platforms or other one-on-one notification channels.
5. Non-interest expenses (NIE) will go down
Implication
Non-interest expenses (NIE) will go down. As physical channels become less favored, and as banks themselves reduce their reliance on them, staffing and other costs related to them will go down.
Suggested action
In any crisis, when a revenue impact is expected and when credit quality might deteriorate and therefore LLP might rise, the prudent thing to do is to try to reduce NIE to protect profitability. The current situation will provide some natural opportunities to reduce staff in face-to-face situations. For example, if branches, at least for certain hours, only offer drive through service, minimum staffing requirements can be relaxed. Likewise branch support operations, including third party services could be managed down.
6. Redesigning the Collections Strategy
Implication
The classic collections approach is driven by a risk management mindset. We find this to be sub-optimal because it fails to recognize the true root causes of the problem which are almost always based on customer personal and/or financial issues.
Suggested action
A more effective approach to collections is to adopt a marketing mindset and work with the borrower to resolve the problem. An even more effective approach is preventative actions. Loans tend to be “low-engagement” products, particularly if the customer does not have a broader relationship with the bank. There are mechanisms to create such “engagement”. The higher the engagement, the higher the probability that the customer will (a) communicate, (b) discuss alternatives, and (c) pay.
7. Channel migration and digital transformation
Implication
Channel migration and digital transformation will have a rare window of opportunity. While it is uncomfortable to speak of opportunity in this time of great concern for public health and the overall economy, we must be pragmatic. Times like these offer opportunities to overcome human behavioral resistance. Examples of such “public stress migration” were recently seen during the euro crisis in Europe with countries that imposed capital controls or temporarily closed or limited access to bank branches. Even demographics and customer segments that had single digit adoption of e-banking, mobile, or even ATMs, migrated in droves. This channel migration stuck after the crisis.
Suggested action
Seize the opportunity. Reach out to the luddite segments and help them. They will be far more willing to be hand-held (figuratively, since social distancing would not suggest that to be a good idea) through channels they have so far avoided.
8. Leadership: The Stockdale Paradox
Implication
Demonstrate leadership internally and in the community. Let’s recognize that banks are respected institutions in the community. Bank employees and the customers they serve value the stability that banks provide to their communities. There is a reason why the proverbial bank building often has imposing granite columns and tries to project a certain gravitas.
Suggested action
Follow the “Stockdale Paradox”. In dire circumstances leaders must do two things: (a) be brutally honest, and (b) provide a rational basis for hope. The second part is what customers and employees will appreciate. In your communications, both internal and external, project the message: “This too shall pass. Our communities will lose members and our households and businesses will face economic adversity, BUT we are here to help you and make sure that when this is behind us – and it will be behind sooner or later – we are in a position to rebuild and restore as much as what we have lost. We will do this together. We are not going anywhere. We have been, are, and will be here to help each of you”.
“Retain the faith that you will prevail in the end, regardless of the difficulties, and at the same time, confront the most brutal facts of your current reality, whatever they may be.”