The end of the year and the beginning of a new one often mark times of intense competition within the banking sector, especially among smaller and medium-sized banks. In an effort to attract deposits right from the outset of the year, many of these banks have embarked on a high-yield deposit campaign. Customers may discover attractive deals that promise not just minimal bonuses but significant returns. For instance, short-term deposit products, particularly those with a seven-day maturity, have seen promotional interest rates effectively reaching up to 7%, drawing considerable attention from savers who are eager to maximize their returns.

Raising interest rates has emerged as a pivotal strategy for some of these smaller financial institutions in their quest for deposits. As 2024 rolled in, major state-owned banks began slashing their deposit rates, prompting smaller banks to follow suit. Some are seeing decreases in deposit rates between 10 to 50 basis points, with certain banks reducing even further. However, against this backdrop of falling rates, a number of smaller banks have chosen to buck the trend, raising their rates to attract deposits. What underlying motivations drive this counter-cyclical approach?

In contrast to larger banks, smaller institutions typically grapple with a more limited pool of funding sources and have to work hard to reach a wide array of clients. For these smaller banks, deposits are a crucial lifeline for scaling operations. Competing amongst themselves and also against larger banks means that smaller institutions have to be adept at attracting savers who are particularly sensitive to interest rate fluctuations. Gaining a larger deposit base directly impacts their capacity to lend, facilitating a more sustainable stream of financing for their lending activities. Thus, in a bid to build a more substantial deposit base, small banks are increasingly likely to offer higher rates as an immediate solution to enhance their liquidity.

From a regulatory perspective, metrics such as loan-to-deposit ratios and the quality of assets on their balance sheets have introduced a layer of scrutiny that smaller banks find difficult to navigate. As these banks prepare for end-of-year evaluations, the drive to compete through interest rate adjustments becomes an unavoidable battle. By increasing rates to attract deposits, some smaller banks can address their funding shortages while also aligning better with performance metrics. This may appear beneficial at first glance; however, the broader banking sector faces rising costs of liability due to this strategy, which undermines the traditional pro-saving behavior. Alarmingly, certain institutions have resorted to dubious practices such as covertly manipulating interest rates or using secretive promotional coupons that violate regulatory guidelines. Such actions not only threaten the security of their deposits but also expose them to severe penalties from regulatory bodies.

Currently, while many smaller banks maintain relatively stable operations and have improved their capital strength, they face a persistent challenge regarding their net interest margins. By the third quarter of 2024, the net interest margin for commercial banks had already plummeted to a historical low of 1.53%. In light of this scenario, the overreliance on elevating interest rates as a strategy for attracting deposits does not seem to offer a sustainable solution for the future.

Small and medium-sized banks play a crucial role in regional economies, supporting local development and broader initiatives such as rural revitalization. Rather than exhausting all efforts to draw in deposits using high rates, these banks should swiftly look to carve out their distinct development paths that align with their capabilities. There is a pressing need to transition from merely pursuing scale to achieving quality in management and operations. Enhancements could be geared towards key areas such as capital adequacy ratios, provisions coverage, and effective risk management—the foundations of robust core banking practices.