Apps, crypto, and even Starbucks cards: Deposit fragmentation has been on a decade-long mission to bring down banking–and it’s not done yet

March 24, 2023, 3:44 PM UTC
Even retail apps like Starbucks, Chick-fil-A, online gaming apps, and many others are siphoning funds away from traditional banks.
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With the news of Silicon Valley Bank’s failure, people are wondering about the safety of our financial institutions. But the reality is, banks fail surprisingly often. The difference with SVB is that its sudden demise impacted a large number of known brands, startups, and venture capital firms who all had complete confidence in their financial partner. And there’s concern that “herd mentality” could cause other companies to start withdrawing deposits from other financial institutions, creating a domino effect.

So, should we be concerned? Yes and no.

The reason banks fund the Federal Deposit Insurance Corporation (FDIC) is to protect against situations exactly like Silicon Valley Bank. Depositors should all recoup their funds, without requiring a tax-funded bailout from Americans. So, in the short term, this will (hopefully) be a blip on the financial radar and a major inconvenience to those companies impacted, but it’s not going to sink the whole economy.

But what about the long term? Are banks healthy?

That’s a more complicated question. Over the past 10 years, many more non-traditional financial institutions have emerged. We’ve got companies like Robinhood and Acorn, mobile banks like SOFI, Chime, GO2Bank, and even cryptocurrency. More consumers are loading their paychecks on pre-paid debit cards not aligned with traditional banks.

Perhaps surprisingly, even retail apps like Starbucks, Chick-fil-A, online gaming apps, and many others are siphoning funds away from traditional banks.

Deposits are being heavily fragmented, and fewer are going to traditional financial institutions. Traditional banks and credit unions have been experiencing an exodus of deposits and the consequences are starting to show.

Market fragmentation wasn’t as much of a concern when banks were full of stimulus checks and PPP money. According to the Federal Reserve, consumers saved more money during the pandemic than ever likely due to a sharp decrease in travel, commuting, shopping, entertainment, and other expenses, as well as by saving what they received in COVID-19 stimulus checks.

In fact, during this time, personal savings soared, with the Fed estimating that U.S. households accumulated about $2.3 trillion in savings in 2020 and through the summer of 2021. All of this activity drove significant institutional growth with historically high loan volumes.

But by the winter of 2021, there were reports that these savings were dropping, especially among lower-income families who were using these emergency funds to simply get by.

Shortly after, in 2022, came the decision to raise interest rates that had, until that point, been hovering close to zero. The rising interest rates were designed to tame inflation, but they also created a new slowdown in homebuying, discretionary spending, mortgages, and revenue streams for banks, creating an unusual period of stagnating growth.

More concerning–a number of traditional financial institutions have been complacent, despite this shift in the financial dynamic. A chaotic economy, lingering concerns over a recession, and the growing skepticism from businesses and consumers in the wake of recent bank failures mean that there are even fewer deposits flowing in to fill the ever-widening gap caused by fragmentation.

Like a glass after it has been broken, there is no putting the pieces back together. We are not going to de-fragment the banking industry and reduce the gap in deposits by eliminating other financial options.

Banks must consider other strategies to get customers back on board. Tactics like personalized savings plans, attractive mortgage offers, and meeting customer needs right at the moment of opportunity will be critical. They need to improve engagement with customers, offer rewards for strong customers, flag attrition faster, and create reasons for customers to stay and grow with the institution

The recent bank failures are a warning sign and an example of the impact that a fragmented deposit market is having on traditional banks and credit unions. Complacency will only lead to further erosion of loyalty and deposits, leaving a literal wealth of opportunities for smaller, more nimble challengers to scoop up.

James White is the general manager of banking at Total Expert.

The opinions expressed in commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.

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