The Secret of NIM

According to the Guinness Book of World Records, the most expensive bottle of water ever sold is the $60,000 Acqua di Cristallo Tributo a Modigliani. It was a one-off, packaged in a 24 karat gold-covered bottle that was sold at a charity auction to combat global warming.

Maybe a nice 750ml bottle of Svalbarei water from Norway’s arctic glaciers for $117, or a liter of ? Amazon Air Water from “the flying rivers of the Brazilian Amazonian rainforest," for $140 is more your style. The 10 Most Expensive Bottled Water Brands (The Prices Will Shock You).

If profit margins can be expanded on something as plentiful and commoditized as water, we surely can do better on the plain old bank account. Even upgrading from the equivalent of the ubiquitous 99 cent generic gas station bottles to the $7 square bottle of Fiji Water can have a dramatic impact on profitability, but we must look beyond the core product itself to find sources of value to the customer.

Deposits are the aqua vitae of banking, the water of life.

The very core of the traditional banking business model is gathering deposits at no to low-cost and lending the money back out at higher rates. Bankers used to reference the “3-6-3 Rule”: bring in deposits at 3%, make loans at 6%, and be out on the golf course by 3:00PM.

?Money is the primary raw material in the business of banking. The difference between what financial institutions pay for that raw material is subtracted from what they earn from lending it out right at the very top of their income statements. That difference is net interest income, and it is the largest component of earnings for virtually every bank. As much as 95% or more for some.

?Expressed as a ratio, the net interest margin, or NIM, is a key metric in measuring bank performance. In the 1990s bankers could afford to get out on the golf course even earlier. In the first quarter of 1994 the average bank NIM was 4.91%, but margins have been under considerable pressure lately.

?“Net interest margins for regional and mid-sized banks have been trending down over the last 30 years, irrespective of economic conditions,” says Tim Mahedy , Founder & Chief Economist at Access / Macro. “Competition from a handful of national banks forced everyone else to concentrate business in a few volatile markets. Then, ‘lower for longer’ monetary policy following the Global Financial Crisis further compressed margins and put bankers on their back foot as economic conditions went haywire during the pandemic”.

Pulling the Levers of NIM

The traditional levers to manage NIM have centered around trying ways to lower deposit rates and/or raise loan rates and hope that volume doesn’t drop too much. This is critical because losing the liquidity from those deposits or the interest income from those loans can easily more than offset a few basis points of improvement in margin.

?Asset and liability pricing and strategies have gotten increasingly complex. Changing the mix and duration of deposits, hedging strategies, maturity transformation, structuring time deposit offers, and strategic use of the securities portfolio to avoid negative convexity are just some of the levers banks can use to improve NIM, or at least fight margin compression.

Alloy Labs member Chris Nichols from SouthState Bank regularly shares best practices on some of these tactics, including this recent LinkedIn post on ways to manage interest rate sensitivity.

But is it Enough?

As we say about so many of the traditional industry tactics and practices, they are necessary, but likely insufficient over the long run. The industry average NIM declined again in the first quarter of 2024 as the increase in liability costs outpaced the gain in asset yields, according to FDIC data. This pain is even more acute for community banks, whose average NIM of 3.35% is 28 bps lower than their pre-pandemic average.

?“Unfortunately, it doesn’t look like conditions will improve anytime soon”, Mahedy says. “Structural factors like climate change, geopolitical tension, and domestic political strife are going to increase economic volatility over the coming decade. That’s going to make the path of rates even harder to predict, making net interest revenue unreliable. That will lead to more consolidation and bank failures. But it’s not all bad news. Innovation comes from finding the bravery to try new things. Banks that can diversify away from the last three decades into new markets will find growth opportunities.”

?The Hidden Levers

The banks best positioned to pull out of this spiral are those who are looking for creative ways to differentiate themselves from their peers and provide new sources of non-rate value for their customers as a competitive advantage. We have an inside view of several examples from within the Alloy Labs ecosystem:?

• TCB - The Cooperative Bank , C&N Bank, and Bristol County Savings Bank were three of the earliest banks to partner with Carefull , an AI-enabled digital platform that enables FIs to protect older adults and their 45 million financial caregivers from $8.8 billion in annual fraud, scams, and everyday money mistakes
• Union Bank of VT & NH is working with Eko , which enables banks to offer a turnkey white-label digital investing solution directly on their existing banking platform
• American State Bank piloted The Postage, Inc. , an intergenerational private family network that connects FIs with the next generation that will inherit $72.6 trillion over the next 25 years.

Better than a Free Toaster

These are all different tactics targeting different strategic customer segments, but what they all have in common is they are giving customers new sources of value and new reasons to engage with their bank. Metrics like daily active users, digital usage and engagement, and email open rates are jumping dramatically. Most importantly, the banks are building stickier, more meaningful relationships in ways that could never be accomplished by bumping up a money market interest rate.

?As time goes on, and with proper marketing support, some are even seeing these partnerships become customer acquisition tools. They’re starting to hear customers say things like, “I want to open that account where I can help keep an eye on my mom’s money.”

?Imagine that, bringing new customers to the bank without expensive teaser rates or a free toaster. Every 1 basis point (0.01%) of margin movement up or down equates to $100,000 per $1 billion.

That could buy a lot of water in fancy bottles.

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JP Nicols is cofounder and Managing Director of Alloy Labs where he helps leaders create competitive advantage to drive new growth through industry-leading best practices,?tools, and frameworks.

He is a top-rated speaker and instructor on innovation, strategy, and leadership at leading graduate schools of banking, and cohost of the Breaking Banks Fintech Podcast , the #1 global fintech podcast.

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