Banks across the U.S. have seen deposits come under pressure over the last few months. Particularly after the failure of Silvergate Bank, Silicon Valley Bank, and Signature Bank in March. But what exactly does this mean and why does it matter to consumers and business owners? For a consumer or a business, when they deposit money into their bank account, that deposit is their asset. But for the bank it becomes their liability. Why is it a liability? Because the depositor can come and withdrawal that money at any time. Banks need to manage their liquidity and capital to operate a profitable and growing operation. Deposits are a large part of banks liquidity. Banks need deposits to lend money. The interest banks pay to customers on checking, savings, money market accounts, and CDs are classified on their balance sheet as interest expense and are known in the banking industry as funding costs.
Starting in 2022, the Federal Reserve Bank began raising interest rates to fight inflation. As a result, banks were able to charge more for loans, while at the same time keeping the interest paid on deposits relatively low because pandemic stimulus had flooded them with deposits (Heeb, 2023). With funding costs low and interest rates increasing throughout 2022, Banks enjoyed increasing profit margins. This began to change in the fourth quarter of 2022, as depositors began to chase higher yielding accounts in the form of Treasury and Money Markets (Stovall & Tariq, 2023). The combined fallout of depositors seeking higher yielding accounts and the bank failures in March, has caused Banks funding costs to increase and thus will lead to lower profit margins (Stovall & Tariq, 2023).
If a bank is losing deposits while at the same time having to increasing funds costs, this can stress a banks liquidity position. If the liquidity position becomes too stressed, a Bank could be forced to reduce lending, cut expenses, and raise capital in order to stabilize profitability and remain within regulatory compliance. In a bad situation, a Bank might be forced to shrink their balance sheet by selling assets and / or enter a resolution or a memorandum of understanding with regulators (Gerrish, 2008). In the worst-case scenario, the Bank could face a “run on deposits,” which could lead to failure.
Banks being able to gather low-cost deposits is crucial to their business model. It is often said that deposits are “the life blood of every bank.” Banks cannot lend money without this funding source and when they have to pay out higher interest for deposits this can hurt their profit margins. Banks have entered a period when they will have to compete strongly for every deposit. A student of banking could argue that banks have not encountered a situation like this since before the great recession in 2007. This new era will undoubtedly cause Banks to put more strategic focus back on deposit gathering.
In the coming weeks we will look at Banks loan to deposit ratios, uninsured deposits, what options are there for a customer that have deposits over the FDIC insured limit of $250,000, and the make up of Bank’s balance sheets and deposit mixes.
Sources:
Heeb, G. (2023, April 16). Banks are finally facing pressure to pay depositors more. The Wall Street Journal. Retrieved from https://www.wsj.com/articles/banks-are-finally-facing-pressure-to-pay-depositors-more-88d6447d?mod=Searchresults_pos1&page=1
Stovall, N. & Tariq, S. (2023, April 11). Liquidity crunch will take a bite out of US bank earnings. S&P Global Market Intelligence. Retrieved from https://www.capitaliq.spglobal.com/web/client?auth=inherit&overridecdc=1&ignoreidmcontext=1#news/article?id=75094708
Gerrish, J. C. (2008). The bank directors’ bible: Commandments for community bank directors (3rd Ed.). St. Pete Beach, FL: Bank Source Publishing.
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