It is no secret that 2020 has been a year like no other. The COVID-19 pandemic, economic shutdowns and government stimulus plans have greatly impacted where the financial industry stands today and where it is headed in 2021.
While the current situation is not, to borrow a euphemistic medical phrase, “swirling the drain,” it’s not an advantageous cycle for financial institutions. Right now, deposits are up. Consumers are saving more thanks to stimulus checks from the government and the pandemic has taught many the importance of an emergency fund. We’re seeing more consumers taking their money out of the stock market and depositing it into a savings account instead.
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Though few financial institutions need deposits, there’s been a concurrent retraction of consumer lending. This year, banks saw early loan growth from commercial lending with the PPP loans while most consumer lending actually declined. Only two areas experienced minimal growth: mortgage and auto loans.
The salt in the wound 2020 has dished up is the lowest rate environment since 1971. This year, the Federal Reserve slashed rates, leading to a refinance boom as consumers moved to save money or adjust their mortgage terms to have additional money at their disposal. You can see where this cycle is heading.
This low-rate environment is furthering margin compression. In 2019, the FDIC reported that banks’ net interest margins were 3.78% and return on assets were 1.09%. These numbers have since fallen to a 3.58% net interest margin and 0.98% return on assets in 2020. The NCUA reported net interest margins at 3.57% and return on assets at 0.60% in 2019 for credit unions. Today, the NCUA shows credit unions’ have a 3.22% net interest margin and 0.38% return on assets.
What’s to Come in 2021
As financial institutions continue to rely on interest income, they will need to focus more on non-interest income sources to lessen their dependence on interest margins and create a stable, profitable portfolio. Over the last few years, the Federal Reserve has warned that non-interest income could become a hedge against interest income by generating fee and sales income independent of market interest rates.
Additionally, many consumers shop for the best rates and demonstrate limited loyalty when it comes to lending. This race will force financial institutions to offer additional value-add components to their loans and retail strategy.
There are many factors that will make it difficult to build and grow a stable portfolio of products in an increasingly complex environment. Fortunately, there are steps financial institutions can make to position themselves better for 2021.
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Overcoming the Challenges of 2021
Financial institutions can offset the impact of lower net interest margins on profitability through cutting costs, increasing non-interest income and increasing loan volume. This is why offering differentiated non-interest income building products, like interchange, fees, and value-added products, is so important. In 2021, non-interest income will become the not-so-secret ingredient for community banks’ and credit unions’ growth and profitability.
Providing loan products that compete on more than rates alone will help attract prospective borrowers and deepen your share of their debt-wallet. Borrowers want more transparency to help understand their debt, more control to see the impact if they paid ahead, and the flexibility to take back extra payments if needed. By offering these benefits in addition to competitive rates, community banks and credit unions will stand apart from competitors in the rate race, deepening borrower relationships, increasing non-interest income and bringing you more of their debt that is held elsewhere.
Furthermore, with fewer consumers physically going into the branch, financial institutions must make the most of every in-branch conversation. Front line staff must take advantage of opportunities to connect with account holders and help consumers change their expectations and how they perceive their debt. When consumers have a better understanding of their debt, they can engage in conversations with the institution knowledgably about what products and features would best serve them.
Sharing this information with current account holders will have a trickle effect to potential consumers as well. When offering strong products and services, personalized experiences, and great customer service, word of mouth marketing can do a lot of the heavy lifting for you, ultimately increasing debt-wallet share.
There’s no doubt 2020 has been one of the most tumultuous, unpredictable years. As we reach the end of the year, looking back at how the industry was impacted gives us clear clues into what lies ahead in 2021. From focusing on increasing non-interest income by offering differentiated products to more efficient marketing strategies to build traction with consumers, banks and credit unions can prepare themselves for the year to come.
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