Reacting to a deposit-rate war: the recession-induced demand for stable financing has motivated many banks to seek additional deposits. But how do you avoid getting sucked into a classic price war with your competitors? We offer four ways to sidestep this trap--without surrendering your deposits or your profits.

• Author: Vidal, David

THE FINANCIAL AND ECONOMIC CRISIS OF THE LAST TWO YEARS has had a profound impact on all U.S. banks' deposit business. First, the urgent need for stable and reliable sources of refinancing combined with increased capital needs has pushed many banks to refocus on deposit gathering. This has led to a dramatic increase in attractive deposit products.

In parallel to this boost in supply, demand for deposit products has also increased, as customers have shifted towards traditional savings accounts in search of less riskier investments. This customer trend should have helped banks build their deposits while at the same time keeping rates at a profitable level. However, what happened in reality is what pricing professionals call a true price war. Driven by the desperate need to grow deposits, some banks increased their deposit rates quickly and dramatically and were followed by competitors afraid of losing their own customer deposits to these aggressive offers.

This upward rate pressure has evolved into a toxic spiral of unprofitable, highly visible mass-market deposit products. This move has been accelerated by a proliferation of Web sites offering rate comparisons that are further spurring customers and pressuring banks to offer even higher rates.

This article summarizes a set of responses developed as a result of the authors' experience with banks struggling in price wars. How can price wars be avoided? If they break out, how can they be slowed or ended? What can be done to escape the price trap and end the toxic spiral? Specifically, the authors describe measures that were developed by and for a regional retail bank to govern its reactions to aggressive rate changes by competitors.

Below are listed the four steps involved in successfully coping with a deposit-rate war.

Step 1: Adapt or redefine your pricing strategy, and learn to pick your fights wisely.

If you are going to engage in a price war, you have to pick your fight carefully. Generally in price wars, preserving or increasing profits is paramount over fighting for volume or market share. However, you must be able to make these choices on a very granular basis and know exactly what you want to fight for--per product and customer segment--and you have to understand the quality and attractiveness, and not only the size, of your deposit portfolio. This can be achieved by answering questions like the following for each product and customer segment:

* How strong is our competitive positioning in this segment? What other factors than rates drive the decision-making of these customers?

* Can we afford to lose these customers? How big is the potential of this segment to generate profits...