Banks must remain laser-focused on deposits

Banks began to feel funding cost relief in the fourth quarter of 2024 as the Federal Reserve eased rates further and those declines should continue. However, funding costs are unlikely to drop materially in the near term. As depositors have woken up to higher rates available in the marketplace, the prospect of significant declines in short-term rates seem unlikely in the near term.

Stronger deposit franchises continue to attract higher valuations in the public markets and in the context of acquisitions. Banks would be wise to keep investing in their franchises by improving their technology and treasury management offerings, hiring deposit-focused teams, marketing more products to existing customers and exploring fintech partnerships that could be easier under the new administration.

Many institutions were not able to pursue unique deposit gathering strategies during 2023 and throughout much of 2024 as the liquidity crunch that erupted in the aftermath of regional bank failures pushed banks to bolster their funding bases however they could. For many institutions, that meant going back to the well and marketing certificates of deposits (CDs) with elevated rates.

That approach shored up liquidity but has since left institutions with a much greater reliance on CDs for funding. CDs represented 27.7% of community bank deposits at year-end 2024, up from 25.6% at year-end 2023 and 18.6% at year-end 2022.

Many of those products carry one-year terms, meaning that institutions might not feel significant pricing relief until CDs originated before the Fed pivot in September 2024 mature. At year-end 2024, the bulk of CDs were set to mature in the next year, with 34.4% of all CDs maturing or repricing in the next three months, while 85.2% of CDs were set to mature in the next 12 months.

When those CDs mature, most banks will have to meet market rates to retain the deposits. While the market has waited for lower rates for some time, CD rates only began declining late in the third quarter of 2024 and appear to have stabilized more recently.

The number of banks marketing one-year CDs with yields over 4% stood at 906 as of Sept. 6, 2024, down only slightly from 928 institutions as of June 28, 2024. That number began to fall more notably in the last week of the quarter, however, declining to 788 institutions as of Sept. 27, 2024. Since the end of the third quarter last year, the Fed has cut short-term rates by another 50 basis points, while the number of banks marketing one-year CDs over 4% has dropped dramatically to 392 institutions as of Feb. 21, 2025.

Despite those rate cuts, there has been less movement in the number of banks marketing one-year CDs over 3.5%. As of Feb. 21, 2025, 1,096 institutions were in that group, down from 1,266 as of Sept. 27, 2024, and 1,289 as of Sept. 6, 2024.

Community banks could find it challenging to decrease deposit rates quickly in the coming quarters as short-term rates stabilize and customers still find alternatives with attractive yields in the Treasury and money markets. Community banks will have to balance growing deposits and lowering rates on their products and will likely need to remain somewhat competitive with the institutional markets.

We think banks should be careful when evaluating that balance and remain mindful that the last few years have served as a reminder that deposits are the true value of a franchise.

Executives should incentivize their relationship managers to grow deposits, not just loans, and would be wise to develop niche teams focused on the largest industries in their local market. Bankers should also utilize their own data to market deposits to existing customers who often have relationships with other financial services firms and consistently transfer funds to those institutions. The all in cost of keeping those funds in house often will be cheaper than having to spend extra money to acquire new customers.

Institutions might also find it easier to pursue fintech partnerships and benefit from the funding that comes with those relationships. Federal Deposit Insurance Corp. Acting Chair Travis Hill has suggested since taking the reins at the agency that the approach to fintech partnerships will be more transparent under his leadership.

Lower rates and the passage of time might offer the opportunity to ease deposit costs, but banks should not lose sight of what drives the value of their franchise.