Fs Viewpoint Driving Deposit Value in Excess Liquidity (1)

8/12/2019 Fs Viewpoint Driving Deposit Value in Excess Liquidity (1)

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www.pwc.com/fsi

When Cash Isnt King:Driving Deposit Value in a World ofExcess Liquidity


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Contents

Section Page

1. Point of view 2

2. Competitive intelligence 13

3. A framework for response 17

4. How PwC can help 28

Appendix Select qualifications 36


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Section 1

Point of view


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When Cash Isnt King:Driving Deposit Value in a World of Excess Liquidity

Point of viewDeposits traditionally provided a core source of bank franchise value, but oversized cashportfolios are pressuring margins, and paradoxically heightening liquidity risk concerns.

Deposit Value Under Pressure

Weak loan growth

Limited pricing tacticsavailable in a near-zero rateenvironment

Regulation Q * repeal apotential margin threat forsmall business portfolios

Liquidity build up due to weakeconomic conditions andheightened risk aversion

Money market mutual fundchallenges

Unlimited FDIC guarantee * ofdeposit balances

Attractiveness of earningscredit rates for corporatecustomers

Recent regulatory changes(Reg E, Durbin) * reduced feegeneration associated withconsumer deposit accounts

Basel III liquidity standards * expected to require costly cash buffers to support deposits

Expiration of FDIC unlimitedguarantee* at the end of 2012creates uncertainty

Retail ring-fencing (UK)* aimsat eliminating implicitgovernment support of wholesale deposits

One of the things that ishappening today, we'renot getting recognized or

paid for the wonderfuldeposit franchise wehave .

CEO of a Top 5 US Bank(October 2011)

Rising deposit levels a boon to the banking industry following the financial crisis have become a majorchallenge. The ability to generate long-lived, low-cost deposits is traditionally one of the most important components of bankfranchise value. However, a perfect storm of industry conditions an expanded money supply, customer delevering, weak loangrowth, near-zero rates and regulatory developments have upended the virtuous cycle of deposit gathering and lending. ManyNorth American banks seeking to enhance profitability and uncertain of the stability of these recent liquidity inflows areactively seeking to stem the growth or even work down their deposit balances.

Rising Deposits Falling NIM Regulatory Threats

*Recent regulatory developments affecting deposit accounts include: the required unlimited guarantee of noninterest bearing deposit accounts included in Dodd-Frank; the repeal ofRegulation Q, included in Dodd-Frank, which prohibited the payment of interest on business transaction accounts; requirement by the Federal Reserve that consumers opt in to certain

overdraft services pursuant to Regulation E; reduction of debit card interchange fees required by the Durbin Amendment to Dodd-Frank; and the liquidity standards included in the Basel IIIInternational Framework for Liquidity Risk Measurement, Standards, and Monitoring; recommendations of the Independent Commission on Banking (UK), September 2011.


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Point of view An additional concern stems from the expiration of the unlimited FDIC guarantee at theend of 2012 and the resulting disintermediation risk associated with these balances.

Balances Covered by Unlimited FDIC Programs, 2008-Present

($bn)

TAGP Dodd-Frank

Source: FDIC

0

200

400

600

800

1,000

1,200

1,400

Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q110

Q2 10 Q3 10 Q4 10 Q111

Q2 11

Guaranteed Amount Excess to $250k

Transaction Account Guarantee Program(TAGP):

Fearing a run on bank deposits, the FDIC instituted thisprogram in 2008 during the financial crisis. The programprovided an unlimited guarantee of non-interest-bearingtransaction deposits. The program became optional as of1/1/2010, and the majority of large banks opted outduring 2010.

Dodd-Frank:

The 2010 financial regulation and reform bill included adeposit insurance provision, specifying that during 2011and 2012, the FDIC must guarantee all non-interest-

bearing balances. Banks are not permitted to opt out ofthe guarantee provisions.

Expiration:The Dodd-Frank unlimited guarantee provision expires12/31/2012. Whether Congress will pass legislation toextend the guarantee, or whether the FDIC will establish areplacement program, is uncertain. The $1.2 billionguaranteed by the program as of Q2 2011 could lose FDICprotection, causing investors to consider alternative risk -free investments such as government securities.


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Point of view

Wholesaleoperational

(25% runoff)

Stabledeposits

(5% runoff)

Less stabledeposits

(10% runoff)

Consumer Small Business

High ValueDeposits

Medium ValueDeposits

Wholesale withtransaction banking

Otherwholesale

nonfinancial(75% runoff)

Otherwholesalefinancial

(100% runoff)

Wholesale withouttransaction banking

Low ValueDeposits

LiquidityPortfolio

A m o u n

t o f l

i q u

i d a s s e

t s

Time under stress scenario

The Basel III liquidity standards include pre-defined runoff factors for variouscategories of deposits. Deposit types with higher runoff assumptions will increasethe required liquidity of the bank and therefore be less profitable.

The Basel III liquidity standards will require costly cash buffers to support possible depositrunoff though the impact will vary by customer and account type.

Under the Liquidity Coverage Ratiostandard banks must maintainliquid assets to offset loss offunding for 30 days under a stressscenario. Each dollar of assumedrunoff requires an offsetting dollarof liquid asset buffer.

Liquidity Coverage Ratio

Under the Net Stable FundingRatio standard, deposits assumedto run off during a one-year stress

scenario do not provide stablefunding and will have to be held inliquidity rather than deployed tolonger-term assets requiring stablefunding.

Net Stable Funding Ratio


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Point of view

0%

20%

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J a

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0

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l -1 0

J a

n-1 1

Structural Liquidity 1 and Deposit Funding Mix 2 of Top 25U.S. Banks

Structural Liquidity as a % of Loans Deposit Funding Mix

Despite the challenges surrounding deposits in the current environment, their importancefor bank funding following the financial crisis remains high.

As evidenced in credit default swap (CDS) spreads, perception among capital markets participants is that the risk profile of banksremains elevated following the financial crisis. This heightened risk negatively impacts wholesale borrowing conditions andimproves the relative attractiveness of deposit funding.

Bank liquidity has grown rapidly since the financial crisis, supported in large part by deposit growth. The liquidity life of depositportfolios will be critically important when loan growth returns to normal levels and banks seek to maintain a strong liquidityprofile while redeploying deposits to longer-duration assets.

0

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Average CDS Spreads of Selected Large FinancialInstitutions

1Structural liquidity is total deposits plus long-term debt plus total equity2Deposit funding is total deposits as a percent of total liabilities Source: FDIC


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Point of viewIn this environment, banks need to employ analytics to more precisely differentiate andtarget specific deposit types supporting balance sheet and margin objectives.

Successful differentiation strategies leverage an in-depth understanding of customer deposit behavior

Balance sheet optimization: Establish a more precisedeposit analysis framework to optimize asset-liability management and drive targeted depositgathering that supports balance sheet objectivesThese frameworks will differentiate between stressed and non-stressed behaviors, as well as more precisely capturingdifferences between specific customer types.

Funds transfer pricing alignment: Overhaul fundstransfer pricing frameworks to more explicitly and

precisely capture the liquidity characteristics ofdepositsThese improved frameworks will drive better alignment between treasury and business line objectives, enhancing

governance and deposit gathering.

Deposit price optimization: Adopt advanced deposit pricing methodologies designed to closely matchdeposit rates to customer price sensitivity Analytic pricing drives spread revenue growth acrossinstitutional and mass segments utilizing advanced statisticaltechniques.

Balance sheetoptimization

Deposit valuecreation agenda

Funds transferpricing alignment

Deposit priceoptimization

Each of these aspects is discussed in greater detail in the remainder of this section


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Point of view

FTP enhancement Deposit priceoptimizationBalance sheetoptimization

Developing a more precise runoff profile of the deposit portfolio improves theeffectiveness and potentially reduces the cost of liquidity risk management.

Deposit liquidity risk is largely due to unexpected runoff. Runoff behavior of deposit accounts variessignificantly depending upon a host of channel, market segment, and even individual customer factors. A

behavioral assessment focusing on these factors enables more accurate runoff expectations.

Banks should assess behaviors that correlate to runoff likelihood, even under stressed scenarios. Relationship tenure, cashmanagement practices, and usage of non-deposit products such as credit and transaction services are among the mostimportant factors to consider.

Generic assumptions concerning broad customer segments are likely to be inaccurate. For example, internet-basedcustomers may respond more quickly in a crisis than institutional clients with large transactional cash balances.

Overstatement of deposit runoff risk results in excess liquidity buffers and exacerbates asset-liability mismatch, therebyreducing the earnings potential of the balance sheet. New regulatory requirements such as Basel III liquidity standards willfurther heighten the buffer cost associated with overly-conservative deposit life assumptions.

Typical behavioral assessment factors

Small BusinessConsumer Commercial andInstitutional

Relationship tenure Checking product

usage

ATM usagefrequency

Rate paid

Internet usage

FDIC coverage

Direct control vs.escrow

Relationship tenure Value-added

product usage

Credit usage

Branch usagefrequency

FDIC coverage

Rate paid

Relationship tenure Credit usage

Treasury and tradeusage

Balance level

Net borrowingposition

Industry segment

Company size

Rate paid

A precise analysis of deposit behavior leads to lower risk of buffer shortfall

L i q u

i d i t y P o r t

f o l i o

Current One MonthFunding Position

Generic View Precision View

One MonthStressedDepositRunoff

ExcessBuffer

BufferShortfall

Minimum One MonthFunding Position

One MonthStressedDepositRunoff


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Point of viewLeveraging a more precise understanding of runoff risk and rate sensitivity enablesdevelopment of deposit gathering strategies that support balance sheet objectives.

Illustrative Deposit Behavioral Segmentation

Transactional Solution UsersNon-rate sensitive customers ready to switchdue to other factors such as fees, credit,relationship strength, and productfeature/function

Example: Small-balance consumer

Illustrative Strategy: Enhance margin byreducing rates on lower balance tiers

Transactional InvestorsRate shoppers with minimal relationship

strengthExample: High-balance small businessesin low customer tiers

Illustrative Strategy: Target suchcustomers at competitors via premium-ratebundle. Enhance profitability andrelationship strength through cross-sell.

Relationship Solution UsersStrong relationships with low rate sensitivity

Example: Private wealth brokerage

Illustrative Strategy: Cost effectively enhancerelationship strength through high-touchvirtual banking

Relationship InvestorsHigh deposit retention rate when offeredcompetitive pricing - existing bank wins theties

Example: Large corporate transactionbanking

Illustrative Strategy: Targeted relationship-based pricing, supported by customer levelanalytics

Rate Sensitivity

Deposit Attrition Risk


Deeper customer segmentation enables not only a more in-depth view of the current portfolio, but also provides insightsinto which specific types of customer are the most attractive and should be targeted for priority investment. Forexample, leading banks are investing in creating differentiated customer experiences for targeted relationship tiers. 1

1PwCs FS Viewpoint, When the Growing Gets Tough , March 2011.


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Point of view


FTP Hierarchy of Objectives Required Segmentation

Basic

Value-added

Strategic

LoB and product profitability reporting

Sales/branch officer compensationPricing desk compensationIncentives

Negotiated pricingCampaign design

FTP optimized offersSegment-targeted product suites

Productstrategies

Target market selectionSales force/branch network designTransaction valuation

Segmentstrategies

Product

Line of business

Company size sub-segments and verticals

Region

Customer: behavioralattributes

Pricing

Profit Allocation

As banks develop more advanced FTP capabilities, they are able to utilize the framework to drive value-added andstrategic activities that reach beyond simply allocating interest margin between asset and liability business lines. Inorder to deliver strategic results, the FTP framework will need to become increasingly granular.

The FTP framework provides the critical strategic linkage between balance sheet objectives,line of business governance, and field activities.


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Point of view At the business line level, deposit pricing should optimize margin revenue by linking ratesto customer sensitivity.

Customer rate-sensitivity is typically non-linear, i.e., evidencing significant willingness to move money atvery high or very low rates, but inertia at rates within an area of inelasticity close to competing rates

Two pricing strategies optimize spread revenue: i) setting a rate just below the area of inelasticity to optimize margin; and ii)setting a rate well above the area of inelasticity to optimize balance generation. Rates close to competitors are typically sub-optimal.

The banks deposit portfolio is likely to contain a range of rate sensitivities depending on factors such as product, new ver susexisting money, customer relationship depth, market competitive conditions, and industry. Segmented deposit products andprecision rate plays are most likely to optimize portfolio spread revenue.

FTP enhancementBalance sheetoptimizationDeposit priceoptimization

Area of Inelasticity

Deposit Rate FTP

Optimal Rates

B a

l a n c e

G r o w

t h

S p r e a d

R e v e n u e

x

Illustrative Deposit Price Elasticity of Demand Curve


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Competitive pricing (such as interest rates, fees)

Convenient branch/ATM locations and hours

Online banking

Personalized customer service

Ability to have all my financial products with one bank

Customized product offers

Breadth of products

Rewards programs (such as points, miles, cash back)

Mobile banking

Factors such as ATM convenience and online functionality are on a par with pricing,suggesting opportunities to gain leverage through differentiated capabilities.

Question: Please rate the importance of the following bank features.

30%

18%

8%

8%

11%

4%

10%

9%

4%

12%

12%

9%

9%

7%

4%

4%

4%

3%

24%

29%

34%

34%

23%

19%

14%

11%

13%

17%

22%

30%

29%

27%

34%

24%

25%

29%

17%

19%

19%

20%

31%

39%

49%

51%

52%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Not important 2 3 4 Very important

Note: Percentages may not sum to 100 due to rounding.

Point of view

FTP enhancementBalance sheetoptimizationDeposit priceoptimization

*PwCs FS Viewpoint, G etting to Know You , April 2011.


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Point of viewStrategies based on an in-depth analysis of the deposit portfolio yield significant andmeasurable economic benefits.

Improvement in Net Interest Margin through Deposit Enhancements (Illustrative)

3.69%3.50% 0.14%

0.01% 0.04%

Current NIM Increased LiquidityPortfolio Duration

Reduced Cash Buffers Reduced DepositPricing

Enhanced NIM

Increase duration ofliquidity portfolio by 1year based on

increase of depositliquidity life

assumption of 1 year

25% reduction incash buffer requiredto support deposit

portfolio

Selected ratereductions on

inelastic accounts

Actual results will vary, depending on several factors such as:

Interest rate environment

Current bank funding position

Revised deposit liquidity life versus current assumptions

Historical deposit pricing practices


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Section 2

Competitive intelligence


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Competitive intelligenceBanks leveraging strong franchises can maintain stable, low-cost deposits, while lessdifferentiated banks have to fashion trade-off strategies.

Industry analysis Interest Cost

BalanceVolatility

Shor t -Term Focu s: Margin-driven deposit

pricing Undifferentiated

customer experience Compete with credit

Deposit Risk/Return Tradeoff: Basic Strategies

Churn & Tu rn : Acquisition-driven

deposit pricing Undifferentiated

customer experience Compete with pricing

Leverage the Franch ise: Margin-driven deposit

pricing Differentiated customer

experience Compete with product,

customer management,and financial strength

Pay Up to Retain: Retention-driven

deposit pricing Undifferentiated

customer experience Compete with pricing

Industry Observations

The success of the largest banks inmaintaining low volatility, low-costdeposits indicates that national banking

capabilities (leading products, branchcoverage) are most advantageous.

The largest banks have also maintainedstable deposit portfolios despite a higherindexing of institutional customers,suggesting that wholesale segments offeran attractive venue for gathering stickydeposits.

The higher rate profile of several banksindicates potential opportunities tooptimize pricing at those institutions.


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Competitive intelligence

0%

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16%

0.20% 0.30% 0.40% 0.50% 0.60% 0.70% 0.80% 0.90% 1.00%

Deposit Cost vs Volatility: Top 25 US Banks (2002-2Q2011)

The largest banks leverage strong product capabilities and network breadth to achievelower deposit volatility and interest cost.

17

Note: Volatility of Deposits defined as seasonally and trend adjusted coefficient of variation of monthly total deposit balances. Results adjusted for acquisitions of Merrill Lynch, National City, WaMu, andWachovia. Source FDIC.

Median= 0.49%

Median=10%

Avg Monthly Deposit Interest Expense as a % of Interest Bearing Deposits

V o

l a t i l i t y o

f D e p o s i t s

Short-Term Focus

Leverage the Franchise Pay Up to Retain

Churn & Turn Additional industry observations

Loan growth is inverselycorrelated with the ability togather low cost deposits.Commercial versus consumerloan mix is not a performance

driverCommercial client satisfactiondoes not correlate with lower costor volatilityBanks that score well in consumersurveys have less volatile deposits.

Big 4 bank

Top 10 bank

Other large bank


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Competitive intelligence What we observe in the industryDeposit management

Case studies of large North American and European commercial banks

Balance sheet optimization:Utilizes customer and account-level analytics to preciselymeasure liquidity life, employinghighly granular segmentation

Liquidity life is measuredbased on customer segment,industry, country, and productutilizing stressed (to setbuffers) and non-stressed (toset durations) attrition models.Models are updated annually.

Liquidity requirements areestablished based on multiplestress scenarios and liquiditymetrics. Deposit run-offassumptions fall into threetiers based on product andbusiness segment .

A general runoff assumption isused for deposit liquidity life, insizing the liquidity reserve,distinguishing only betweeninsured and uninsuredbalances.

Funds transfer pricing:Required cash buffers explicitlycaptured in FTP based onsegmented behavioral lifeanalysis. Duration and interestsensitivity also modeled basedon in-depth segmentation

Assigns deposit durationbased on historical attritionbehavior across products,customer size, industryvertical, and other behavioralattributes. Partialsegmentation is captured instandard FTP schedule whilemore advanced segmentationis reflected in deal pricing.

Business as usual behaviorallife modeling drives durationassumptions for FTPpurposes. Stressed runoffmodeling drives determinationof required liquidity buffer andbuffer charges included inFTP. Segmentation includesbusiness segment and region.

Liquidity attributes arecaptured through liquidity termpremiums. FTP componentsare applied based on assumedmix of core versus volatilebalances and non-stressedduration.

Deposit price optimization:Building pricing strategies andtactics based on modeled priceelasticity curves that preciselyquantify the rate-volumerelationship.

Analytic pricing group utilizesproduct, region, and segment-level pricing curves to setrates. Advancedmethodologies are also usedto determine customerreference rates.

Retail deposit rates are set byproduct, segment, and regionbased on regular review ofcompetitive rates andbalance/margin objectives.Commercial rates are setbased on FTP and/or changesin wholesale rates.

Rates are set by product, butnot differentiated regionally.Rates based on FTP and/orchanges in wholesale rates.Rate positioning is generallylow and balance growth lagspeers.

Leading On par Lagging


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Section 3

A framework for response


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A framework for response A framework for improvement leverages in-depth understanding of customer behavior andintegrated governance to profitably gather deposits.

Deposit ValueCreation Roadmap

Behavioralassessment

Strategydesign

Capabilityinvestment

Model liquidity life, interest

sensitivity by behavioralsegment and Basel IIIcategories

Optimize liquidity buffers and

hedging requirements for riskand Basel III objectives

Automate data capture

and ongoing behavioral analytics

Assess FTP frameworkrelative to modeled behaviors by segment

Enhance FTP frameworkand treatments to betteralign to liquidity behavior

Implement customer-level FTP tool fornegotiated pricing

Analyze deposit elasticity by product, segment, andflow

Design pricing strategies tooptimize margin, support balance sheet objectives, anddrive penetration in targetsegments

Upgrade deposit pricingmethodologies, governancecapabilities, processes, andtools

Balance sheetoptimization

Funds transfer pricingalignment

Deposit priceoptimization


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A framework for responseEstablishing a robust understanding of how each segment behaves in managing deposit balances provides the foundation for strategy design.

Customer behavior when theymo ve, add to, or reduce theirdepos i t ba lances and why provides c r i t i ca l inpu ts to l iqu id i ty - based f rameworks wi th in theins t i tu t ion

Liquidity Risk Framework:Establishing the true net fundingposition under normal and stressedconditions by preciselyunderstanding run-off behavior

Asset/Liability Management(ALM): Determining the correctinterest sensitivity by moreaccurately estimating re-pricingrequirements through the next ratecycle

FTP: Correctly reflecting the trueliquidity benefits and costs

Deposit Pricing: Optimizing ratesby more closely matching prices tocustomer rate sensitivity

RateSensitivity

CustomerDeposit

Behavior

Expected life of acustomer depositunder non-stressedconditionsReflects relationshipattributes andattitudes

Likelihood ofbalance changesdue to systematicnon-price factorssuch as marketliquidity levels andregulatory eventsReflects thedegree to whichfactors other thanpricing and stresssystematicallyimpact behavior

Non-StressedLiquidity

Life

StressedLiquidity

Life

MarketConditions

Level of customersensitivity tocompetitor andwhole sale ratechangesReflectssophistication andrelationshipattributes

Likelihood of depositloss underidiosyncratic andsystemic stressconditionsReflects FDICcoverage,sophistication, riskappetite, andrelationshipattributes

Behavioral Assessment

StrategyDesign

CapabilityInvestment


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A framework for responseThe behavioral assessment begins with segmentation analytics that capture commoncharacteristics of customers typically across top-down bank lines of business.


StrategyDesign


Behavioral Segmentation Example

Net CreditPosition?

RelationshipTenure > 5 yrs

Top 2 CustomerTiers?

Consumer

Small Business

Commercial

Risk Tier

Low Risk(3 yes)

Medium Risk(2 yes)

High Risk(0/1 yes)

Yes

Yes

Yes

Yes

Yes

No

No

No

No

Yes

Yes

Yes

Yes

No

No

No

No

Yes

Yes

Yes

Yes

No

No

No

No

Yes

Yes

Yes

Yes

Yes

Yes

No

No

No

No

No

No

Yes

Yes

No

No

No


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$0

$10

$20

$30

$40

$50

$60$70

$80

$90

$100

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Viewing deposit behavior at the customer level reveals a mix of very stable and more volatile balance types.


StrategyDesign


Liquidity Life: Illustrative Customer View

Strategic CashReserve

OperationalLiquidity Buffer

CoreTransactionalCash

A precise analysis of liquidity life should include consideration of three functions of cash on deposit: core transactional cash, anoperational liquidity buffer, and strategic cash reserves. The likelihood of runoff is significantly different for cash used for eachthese functions. Each customer segment requires different levels of cash used for each of the functions.

Strategic Cash Reserve Large liquidity build ups, typically temporary due to large inflows or planned purchases. Emphasis on yield. Highestlikelihood of runoff.

Operational LiquidityBuffer

Rainy day money retained for liquidity risk objectives. Emphasis on liquidity (money market deposit account (MMDA),2a-7 funds). Moderate likelihood of runoff.

Core Transactional Cash Minimum cash required for day-to-day banking. Emphasis on convenience (checking). Lowest likelihood of runoff.


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A framework for responseMore in-depth segmentation based on liquidity behavior enables balance sheetoptimization and FTP enhancement.

Deposit Behavioral ComponentsNon-Stressed Liquidity Life Expected attrition horizon of deposit funds under non-stressed conditions. Important for deposit valuation and baselining stress test assumptions.

Stressed Liquidity Life Likely attrition rate under stressed conditions. Important for sizing liquidity buffers.

Rate Sensitivity Required re-pricing in response to wholesale rate changes to avoid account attrition. Import for deposit valuation as well as setting optimal rates.

Market Factors Systematic response to non-stress and non-rate factors such market liquidity level changes, regulatory events,and equity market developments. Important for reconciling historical behavior to expected future behavior.

$(1,000,000)

$-

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

$7,000,000

$8,000,000

0 18 36 54 72

Consumer

Small Business

Commercial

Middle Market

Large Corp.

Months

Balances

Liquidity Life by Segment Non-Stressed (Illustrative)

0

20

40

60

80

100

120

1 13 25 37 49 61 73 85

Percentage

Number of Days

Retail Demand

Retail Savings

Large Corp.

Deposit Depletion Stressed (Illustrative)


StrategyDesign



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A framework for responseIn order to optimize customer pricing, account-level elasticity analytics are required.

Step 1: Account Waterfall Step 3: Elasticity Assessment

0

5

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1520

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35

S e p - 2

0 0 8

J a n - 2

0 0 9

M a y -

2 0 0 9

S e p - 2

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J a n - 2

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M a y -

2 0 1 0

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0 1 1

M a y -

2 0 1 1

S e p - 2

0 1 1

MMDA: Monthly Waterfall Analysis

Acquisition

Switch In

Change toExisting

Switch Out

Attrition

Confirm segmentation cells (e.g., product,

business segment, new vs. existing,householding)Collect, validate, and clean account-leveldataMap accounts to segment structureConfirm business rules for account flows(e.g., expected run-down period for closedaccounts)Perform waterfall analysis of account flowsby cell

Confirm reference rate methodology (ratesto be used and competitive samples)Calculate reference ratesReview rate-volume time series by cell andadjust for outliers/unusual eventsModel relative rate-volume regressionsutilizing single-variate best fit

Assess curves: evidence of non-pricefactors, limitations of rate experience, levelof fitFinalize pricing equationsScore elasticity by cell and conclude relativeelasticity across cellsReview current rate positioning for priorityopportunities to optimize pricing

Acquisition

Relative Rate

Step 2: Rate-Volume Regression


StrategyDesign


The elasticity-based deposit pricing methodology comprises three steps . First, deposit customers, accounts, and account flow

types are segmented and mapped to prepare the balance flows to be modeled. Second, a regression is performed to quantify thecorrelation between each historical balance flow and rate position. Finally, elasticity is assessed based on the regression output.

High elasticity Minimal elasticity

Pro-duct

Acqui-sition

Checking

InterestChecking

Savings

MMDA

3 Mo. CD

6 Mo. CD

Region 3Region 2Region 1

Attrition Acqui-sition Attrition Acqui-sition Attrition


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0.10% 0.10% 0.10%

1.00%0.50%

0.30%

0.15%

Core Portion(50%)

Non-CorePortion (50%)

Blended FTP

Overnight Funding Rate Matched Funding RateTerm Liquidity Premium

In order to capture liquidity life behavior in the FTP framework, a contingent liquiditymethodology is employed.

StrategyDesign



FTP: Blended Methodology FTP: Contingent Liquidity Methodology

Core portion is assumed to be stable and receives matchedfunding rate and term liquidity premium based on liquidity life

Non-core portion is assumed to have no liquidity life and receivesovernight funding rate

FTP is understated when non-core liquidity life is realized such asunder a non-stressed scenario

FTP is overstated if core portion is subject to run-off, such asunder a stressed scenario

The full balance is assigned a liquidity life under non-stressedassumptions, receiving matched funding and term liquiditypremium

Required contingent liquidity is estimated based on stressedscenario modeling (or regulatory requirements), resulting in aliquidity buffer charge

Total: 1.40%

Total: 0.75%

0.10% 0.10%

0.75% 0.75%

0.30% 0.30%

(0.40%) (0.40%)

Full Balance Liquidity BufferCharge

FTP

Overnight Funding Rate Matched Funding RateTerm Liquidity Premium Liquidity Buffer Charge

Total: 1.15% Total: 0.75%

Business as usual behavioral life should determine the duration assumptions for FTP purposes. Stressed runoff modeling shoulddetermine the required liquidity buffer and buffer charges included in FTP. Robust segmentation should enable precisiontreatments.


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A framework for responseUtilizing elasticity analytics, the bank can design and calibrate price optimization strategiessuch as grandfathering.

Illustration: Product GrandfatheringExisting consumer MMDA product is priced close to competitors within the area of inelasticity due to rate insensitivity

Reduce the rate on the existing product with minimal balance loss based on elasticity analytics

Introduce new low-rate savings product with marginally more attractive pricing and grandfather existing product

Introduce new premium-rate product for new money campaigns

StrategyDesign



Balance

Rate

FTP

Grand-fatheredProduct

NewStandardProduct

Standard Pricing Zone

New Acquisition

Product

PremiumPricing Zone

PreviousPricing Zone

Area ofInelasticity

Illustrative Deposit Pricing Strategy for Consumer MMDA


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StrategyDesign



Translating optimal pricing strategies into actionable tactics typically requires adjustmentsto the product continuum.

Basic Checking PremiumChecking Analysis Light AnalysisStandard Hybrid

TargetCustomer

Small business

with modestbanking needs

Small businesswith large

balances andbasic cashmanagement

Small businesswith more

complex cashmanagementneeds

Corporation withfull cashmanagementneeds

Corporation withfull cashmanagementneeds seekinginterest onexcess balances

ServiceLimitations

No analysisservices andlimited monthlyitems

No analysisservices and highmonthly items

Limited analysisservices and highmonthly items

Full analysisservices and highmonthly items

Full analysisservices and highmonthly items

Fees None Medium (balanceoffset) Medium Medium High

ECRPositioning N/A N/A Low Medium Low

InterestPositioning No interest Low interest No interest No interest Low interest

Illustration: Business checking product continuum

Each customer maps to oneproduct based on profile

Pricesensitivity

reflected inpricing

Fences preventgaming by

customers (andsales officers)


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A framework for responseTo support ongoing excellence in deposit pricing, a bank must excel in four areas ofcapability.

PricingMethodology

DepositCapabilities

Linked to observedcustomer rate sensitivity

and valueBased on thecustomers marketreference point

Exploits segment/geographic differentials

Test and learnapproach

Governance

Centralized datacapture and pricing

analyticsControlled exceptionmanagement driven bythe center

Field flexibility to drivecustomer profitability

Aligned business line,branch, and salesofficer incentives

Pricing Process

Automated analyticsand rate management

Timely exceptionresolution

End-to-end processautomation for depositaccount on-boarding

Technology

Warehousing ofrequired segmentation

data Automated depositanalytics utilizing tools

Automated data feedscapturing internal andexternal data needed torefresh reference ratesand regressionanalytics


StrategyDesign


Establishing a competitive advantage in driving deposit value is not a one-time or periodic effort. Leading institutions invest intechnology, human capital, advanced methodologies, and process improvement to ensure ongoing advantage.


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Section 4

How PwC can help


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How PwC can help A cross-functional capabilities diagnostic enables the bank to identify priority improvementopportunities and associated business cases.

Treasury Lines of Business

Capabilitiesdiagnostics

Assess current methodologiesand frameworks for incorporatingdeposit behavior in liquidity riskanalysis, reporting, and decision-makingReview the FTP frameworkrelative to leading practices and

emerging regulatoryrequirements Assess FTP governance andprocesses relative to leadingpracticesEvaluate deposit organizationaland system capabilities relativeto leading practices

Evaluate the deposit product and sales operatingmodels relative to leading practicesMeasure customer deposit penetration andavailable headroom by product, segment, andregion based on PwC wallet models

Assess deposit product continuum relative topeers based on benchmarking, vendor data, and

PwC data setsReview deposit pricing framework andmethodologies relative to leading practicesHypothesize optimality of deposit pricing basedon balance performance relative to competitiverate positioningEvaluate deposit organizational and systemcapabilities relative to leading practicesSynthesize findings in a capabilities diagnosticdeliverable, identifying key opportunities andrecommending an improvement roadmapBuild a business case quantifying the projectedrevenue impact by opportunity

Deliverables Treasury capabilities diagnosticidentifying key opportunities andrecommending an improvementroadmapBusiness case quantifying theprojected economic impact byopportunity

Capabilities diagnostic by line of businessidentifying key opportunities and recommendingan improvement roadmapBusiness case quantifying the projectedeconomic impact by opportunity

Deposit behavioralassessment

Deposit pricingreview

Capabilitiesdevelopment

Funds transferpricing review

Depositcapabilitiesdiagnostic


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How PwC can helpThe behavioral assessment provides the foundational analytics to design FTP and depositpricing enhancements.


Depositbehavioralassessment

Scope and develop account-leveldata request, which will includedeposit and firmographic informationProcess, map, and validate account-level dataConfirm segmentation cells for FTPanalysis purposes

Analyze stressed and non-stressedliquidity life based on vintage-leveldecaysConfirm optionality variables to betested and model balance behaviorModel rate sensitivity ofadministered rate products based onregression analysis

Scope and develop account-level datarequest, which will include deposit andfirmographic informationProcess, map, and validate account-leveldataConfirm segmentation cells for pricinganalysis purposes

Gather competitive rate data and calculatereference ratesModel rate elasticity based on regressionanalysisModel rate sensitivity of administered rateproducts based on regression analysis

Deliverables Behavioral assessment synthesizingthe results of the analysis, which willidentify for each cell the liquidity life(stressed and non-stressed),optionality, and rate sensitivity ofeach segmentation cellSummary of implications of theanalysis and priority next steps:opportunities to enhance FTPmethodology, calibrations,governance, and supportinginfrastructure

Behavioral assessment synthesizing theresults of the analysis, which will identify foreach cell the rate sensitivity of eachsegmentation cellSummary of implications of the analysis andpriority next steps: hypothesized priceoptimization strategies







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How PwC can helpThe deposit pricing review leverages elasticity analytics to fashion pricing strategies thatoptimize margin, support balance objectives, and drive performance in target segments.

Lines of Business

Depositpricingreview

Confirm segmentation cells (products, regions, customersegments, etc.) to be assessed based on behavioralassessment and strategic prioritiesBased on behavioral analytics, assess relative elasticity acrossall cells (e.g., scale 1 - 5)Based on behavioral analytics, create price-volume equationsfor each cell

Model alternative rate scenarios rate changes andassociated volumes to determine one or more optimal ratepositions for each cellIdentify opportunities to re-price exceptioned accountsDesign and recommend pricing alternative strategies by cellDesign and recommend product strategies by cell to supportpricing strategy alternativesModel financial impacts of each alternative strategy

Assess customer impacts of each alternative strategy

Deliverables Exception pricing analysis: recommended re-pricing actions byaccountElasticity analytics: pricing curves by segmentation cell wherestatistically predictiveElasticity summary: elasticity rating by segmentation cellbased on regression functional forms and slopePricing strategy: recommended rate positioning bysegmentation cell and financial impactCustomer impact: assessment of rate impacts on customersegments







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How PwC can helpThe funds transfer pricing framework will need to be reassessed based on the in-depth behavioral assessment and leading practices.

Treasury

Fundstransferpricingreview

Review existing FTP framework and calibrationsConfirm segmentation cells (products, regions, customersegments, etc.) to be assessed based on behavioralassessment and strategic prioritiesReview FTP framework relative to peers and provide feedbackon leading practices currently employed and potentialimprovement opportunities

Based on behavioral analytics, assess liquidity life and interestsensitivity across all cells

Deliverables Recommended enhancements to the FTP framework to bettercapture liquidity risk characteristics across deposit and liabilityproductsRecommended additional segmentation of FTP whereappropriate based on behavioral analyticsRecommended model calibration changes based onbehavioral analyticsPro forma impacts of recommendations







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How PwC can helpInvesting in capabilities enables the bank to establish ongoing methodologies, governance,processes, and tools for deposit value creation.



Recommend ongoing FTPrecalibration process as needed tosupport planned enhancements

Assess implications of FTP pricingchanges on rate governance andrecommend enhancementsRecommend opportunities to

improve FTP analytics throughautomated solutionsDesign, develop, and implementFTP tools to supportrecommendationsTrain staff in advanced FTPconcepts and methodologies

Design process for ongoing application ofanalytic deposit pricing methodology

Assess implications of deposit pricingchanges on rate governance andrecommend enhancementsEvaluate current staffing levels and structuredevoted to deposit management and

recommend enhancementsRecommend opportunities to improve ratemanagement through automated solutions

Assess current technology utilized for pricinganalytics and recommend enhancementsDesign, develop, and implement depositpricing tools to support recommendationsTrain staff in advanced deposit pricingconcepts and methodologies

Deliverables Capabilities assessment:methodologies, operational models,supporting capabilitiesTool development andimplementationTraining

Capabilities assessment: methodologies,operational models, supporting capabilitiesTool development and implementationTraining







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How PwC can help

ExperienceOur teams have significant experience in performingcomprehensive evaluations of deposit capabilities, depositpricing and fund transfer pricing for several large and private banks. Throughout these evaluations, areas of focus haveincluded:

Assessing the liquidity frameworks ability to meet theexpectations of various regulatory bodies and prioritize

action plans to ensure the stress testing framework meets orexceeds regulatory expectations.

Assessing the key regulatory, operational, financial, andstrategic risks posed by various deposit strategies

Diagnosing FTP frameworks to assess how effectively theframework matches the typical deposit behavior in businesssegments

Recommending elasticity-based pricing strategies for eachproduct to move rate position closer to the optimal rate- balance point based on detailed analytics and analyses

Recommending rate governance enhancements to centralizedeposit pricing in product management

Understanding the key regulatory, operational, financial,and strategic risks posed by various deposit strategies

Providing guidance on opportunities to enhance the depositcontrol environment

Clients

PwC team members have performed deposit or liquidityrisk analysis engagements for a wide variety of clients.Selected recent clients include:

Commercial services division of a Big 5 Canadian bank

Corporate treasury division of a Big 5 Canadian bank

Corporate banking division of a UK-based global bank

Retail and commercial divisions of a Top 5 East Coastregional U.S. bank based

Private banking division of an East Coast community bank

Corporate treasury and commercial division of a Top 25Midwest regional bank

Retail division of a Top 10 East Coast regional bank

Small business division of a Top 10 Midwest regional bank

PwC is distinguished by the depth and breadth of its professionals.


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Section 5

Select qualifications


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Select qualificationsReadiness for Reg Q repeal Large North American bank

Issues A large North American bank sought to ensure readiness for the repeal of Regulation Qs prohibition oninterest-bearing business transaction accounts as prescribed by Dodd-Frank.

Approach Utilized a behavioral segmentation methodology to risk-tier each small business and commercial customer based on propensity to attrite in response to a competitive interest offer. Factors depended upon segment andincluded product usage, balance level, and current pricing/ECR position.

Compiled industry intelligence on likely competitor responses.

Interviewed sales teams and select customers to assess need for new offers post Reg Q repeal.

Designed and modeled financial impacts of multiple potential product continuums, ranging from taking noaction to actively marketing new, premium-rate products.

Benefits Based on our analysis, the bank was able to comfortably conclude that taking minimal action in response to RegQ repeal would best control margin compression and was unlikely to result in a competitive disadvantage.Subsequent events following the effectiveness date of Reg Q repeal in July, 2011, validated our analysis of likelycompetitor and customer actions.


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Select qualificationsDeposit price optimization Large North American bank

Issues A large North American bank sought to implement improved deposit pricing practices in its commercialsegment. Pricing decisions were highly decentralized, with relationship teams able to price customersindividually within broad guidelines set by product management. The objective of the assessment was to testhow effectively relationship teams had priced deposit accounts relative to customer elasticity.

Approach Modeled price-elasticity curves based on account-level analysis of all business customers, segmented bymultiple factors including company size, region, industry, product usage, and balance tier.

Assessed rate positioning relative to theoretically optimal rate points on the elasticity curves.

Tested field discipline in following pricing guidelines by analyzing account attributes, validating that accountexecutives frequently priced outside of guidelines and failed to perform re-pricing reviews.Performed an FTP diagnostic to assess how effectively the framework matched typical deposit behavior in

business segments.

Based on the analysis recommended pricing strategies for each product to move rate positioning closer to theoptimal rate-balance point. The recommended pricing strategies ranged from downward re-pricing in certainsegments and products to introduction of premium-rate small business accounts.

Recommended a new administered-rate product for large customers expected to generate significant volumesthrough a rate enhancement while receiving more favorable FTP treatment.

Recommended rate governance enhancements to centralize deposit pricing in product management.

Benefits Following our analysis, the product management team validated our findings with the relationship teams andreached consensus within the bank that over $30 million CAD improvement in margin was achievable throughre-pricing of accounts and strengthened pricing controls.


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Select qualificationsPost-merger integration of deposit operations North American regional bank

Issues A North American regional bank was faced with the challenge of integrating three recently acquired community banks based on the west coast. This required integration of commercial lending, residential mortgage, treasuryand deposit services as well as investment management and trust business units. Operationally this integration

was particularly challenging in the deposits area as each of the banks had its own products, pricing, vendorrelationships and processing models. Additionally, it would be difficult to bridge the customer experience gap

between the community banks and the clients private banking model while simultaneously achieving thesynergy targets established by management.

Approach Reviewed existing liquidity management policies, methodologies, and reports to gain an understanding of thefirms current liquidity risk practices and metrics from both liquidity and funding perspectives.

Interviewed key stakeholders in Treasury and Finance to gain substantive detail regarding the currentapproach and vision for future developments in this area.

Prepared an evaluation of the organizations current liquidity risk metrics, limits, reports, policies, andoversight practices, relative to industry standards, to identify any differences or potential gaps andimprovement opportunities.

Conducted a proprietary benchmarking survey to collect data from selected institutions to gain a deeperunderstanding of liquidity management practices at leading financial institutions.

Benefits PwC was able to assist the client throughout the integration journey starting with the planning phase during which synergy targets were calculated. This was followed by implementation of a new integrated organizationmodel and rationalization of the disparate products. Next came the mobilization phase, during which specificresources within each region were identified to act as integration agents, vendors / third parties were contactedand asked to provide for a larger footprint and new operating models were defined for servicing, new businessgeneration, treasury operations and support functions. PwC helped the client to meet all of its Day 1 objectivesfrom a regulatory/legal perspective and to achieve a seamless re-branding of its west coast divisions.


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Select qualificationsLiquidity risk management review and benchmarking initiative Large North American bank

Issues A large retail, commercial, and wholesale bank in North America was having difficulties with its liquiditygovernance processes and the communication of critical liquidity information to senior management and the

board. The organization was also concerned about how its liquidity management approach compared toindustry practice at peer institutions.

Approach Designed an integrated future state operating model based on a hub-and-spoke approach which leveragedsynergies while providing an improved customer experience at each of the west coast branch locations

Developed a methodology for comparing deposit products, services and features across the four banks todetermine the optimized end state product portfolio and the roadmap for reaching the proposed end state

Proposed and facilitated the implementation of an end state deposits organizational structure, includingdefining key reporting lines, client ownership policies, roles and responsibilities, etc.

Developed a detailed project plan for integrating risk assessment processes across the four banks,implementing the common core platform and including the integration of various disparate systems (lockbox,cash management, teller platform, etc.) onto the common core

Benefits PwC provided an extensive list of recommendations for improving the clients liquidity management practices.The recommendations included enhancement opportunities in the areas of governance and organization,policies and procedures, analytics and reporting, and data and infrastructure. For each recommendation, PwCidentified the business functions that were affected by the proposed changes; the area of liquidity managementthat was affected (i.e., tactical, structural, and contingent) the prerequisites required for implementing thechange; the priority of the effort; an estimated timeframe for completion; and the benefits that could be derivedfrom each change.


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Select qualificationsLiquidity management review Large North American bank

Issues The client needed to perform a liquidity management review as part of a larger initiative to assess the banksgovernance, risk management, and controls on an enterprise-wide basis.

Approach PwC performed the review in two phases. The first phase focused on the risk management practices related to wholesale bank liquidity, while the second phase focused on liquidity risk management at the enterprise level.Both reviews addressed governance, reporting measures, limits and analytics, and the liquidity riskmanagement control infrastructure.

The review focused on assessing five key areas of liquidity risk management:

- The banks global liquidity framework

- Risk identification and escalation processes when liquidity issues arise

- Information about liquidity available to management and the board

- Integration of recently acquired entities into the global liquidity framework

- Involvement of independent risk oversight in managing liquidity risks and key assumptions impactingliquidity risk management

PwC conducted a series of interviews with key liquidity management staff to understand relevant policies,procedures, and mandates.

Benefits PwC developed a series of recommendations for improvement, including identification of specific gaps PwCand their impact, along with recommendations to close the gaps. As part of the assessment, PwC evaluated theinstitutions practices against regulatory guidance and peer institutions in order to provide insight into how theclient could bring its practices more in line with industry standards. Additionally, the client was able to utilizethe PwC report as required documentation for submission to its regulator in response to action items resultingfrom the clients most recent regulatory review.


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2011 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rightsreserved. PwC refers to the US member firm, and may sometimes refer to the PwC network.Each member firm is a separate legal entity. Please see www.pwc.com/structure for furtherdetails. This content is for general information purposes only, and should not be used as asubstitute for consultation with professional advisors.

When Cash Isnt King: Driving Deposit Value in a World of Excess Liquidity,PwC FS Viewpoint, December 2011. www.pwc.com/fsi

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