By Ray Birch
LAKE FOREST, Ill.—The Fed’s major policy shift in its approach to inflation is a “game changer” for financial institutions, asserts one economist, who expects the move will bring even tighter net interest margins, more competition for deposits and even the potential for annual fees for CU membership.
As CUToday.info reported, the Federal Reserve has announced a significant policy shift in its approach to inflation and in how it will consider other economic metrics. Practically speaking, the shift indicates the Fed moving forward will be less inclined to increase interest rates when the unemployment rate falls, as long as inflation isn’t on the rise.
The Fed said it is looking at averaging 2% inflation over time, a departure from its annual goal of 2%. Fed Chairman Jerome Powell said the Fed will look to tolerate slightly faster consumer price increases if the labor market is strong or strengthening. What that means is extended low interest rates, including on mortgages and business loans, according to analysts.
Michael Moebs, economist and CEO at Moebs $ervices, agrees, and he called the policy is one of the most significant statements from the Fed in many years, bringing on a banking environment that will force FIs to make many adjustments.
“Without a doubt the Federal Reserve on August 27, 2020, led by Chair Jay Powell, made its most important statement since President Truman gave the Fed its dual mandate of maximizing employment and price stability in 1947,” stated Moebs.
The New Moneyball
Moebs compared the Fed’s policy decision to how Billy Beane, as VP of operations for the Oakland Athletics and as featured in the movie Moneyball, changed Major League Baseball with his greater emphasis on wide range of data to determine the impact and value a player is having on the team.
“Billy Beane changed baseball, and the Fed’s recent announcement will change the game in financial services,” asserted Moebs. “It’s a new way of looking at things for all depositories. This is no longer a price situation, it’s also a money situation.”
What has taken place at the Fed, according to Moebs, is an acceptance of all demand and supply economic elements.
With money supply becoming as much of a factor as interest rates, the additional funds flowing into the economy money will become more “fluid,” and that will lead to much greater competition among FIs for all deposit account types.
“Savers will experience more interest rate change in deposits as banks, credit unions and thrifts compete for a greater, fluid money supply. Savers will start to experience changes similar to investors in bonds and stocks,” said Moebs.
Michael Moebs
‘Battle for Deposits’
Moebs believes many deposit rates will begin to change, likely on a weekly basis.
“Banks and credit unions will see money moving faster,” said Moebs. “The average saver—not just investor—is now going to say the technology is here, the money is here, and I can now find the best rate on my share account across the country. There will be a battle for deposits not just from investors, but from savers, too.”
With greater competition raising rates among basic deposit accounts, financial institution margins will shrink as their core deposits will cost them more, forecast Moebs.
“Net interest margins will become tighter, therefore, depositories will need to concentrate on two factors which they control,” said Moebs. “Since the revenue source of net interest margin will fall, fees will have to increase. In the next five years it will become common to have the amount of revenue from managing loans and investments less deposit interest to equal net fee revenue—about 10% of all financial institutions are already at this position.”
Reduction in NI Expense
There will also be pressure to substantially reduce non-interest expenses.
“Fewer employees, higher productivity and stronger compensation may well be the solution. Expenses to assets will mirror the Fed’s inflation target of 2%,” he said.
Moebs said all of this is leading to fewer branches and fewer staff. He emphasized financial institutions will need to cut back on unproductive employees to focus on paying more to those who are the most productive.
Moebs added the productivity focus can’t just be internal, emphasizing credit unions can no longer afford to bring in unprofitable members, such as the single-service indirect loan member.
“Credit unions will have to find ways to bring in new, indirect members with an approach that leads them to taking more than just one service,” he said.
An Annual Fee?
Moebs also believes credit unions will have to charge some members an annual fee for being part of the credit union.
“No longer can you afford to have a $5 share account that costs you $40 a year to manage,” he said. “Instead you need to have a $40 annual fee so every member is doing their part to support the cooperative. And you will need IT to develop a program that readily identifies your profitable and unprofitable members, because you can’t treat all members the same anymore.”