Everything Bankers Thought They Knew About Deposits Might Be Wrong
Some key assumptions that have underpinned banking for years could be due to change in this new environment
By Telis Demos
How could Silicon Valley Bank and other lenders have been so blind to interest-rate risk?
Habits formed over many years of low rates may have had a lot to do with it.
As it accumulated billions worth of fixed-rate Treasurys and mortgage bonds in recent years, SVB failed to anticipate the speed at which the Federal Reserve would move with interest-rate hikes last year.
But the bank’s rapid rise this century took place mostly in an era of very low interest rates and freely flowing money.
SVB isn’t alone in this.
Bankers, regulators, analysts and investors are now being asked to contemplate things that may not have happened in decades, while relying on expectations of market and customer behavior formed during the easy-money era.
“For the last 15 years, almost all deposit behaviors were masked, and looked similar,” says Bob Warnock, senior client adviser at Curinos, which provides data and insight to financial institutions on deposits and lending.
“You would need a team that has been around since the 1980s to understand what the next several years might look like.”
When banking risk was talked about in recent years, it was often about the kinds of things that precipitated the last crisis: Derivatives gone awry; poorly underwritten loans to consumers; the dangers of banks being too big or too complex.
Even as the Fed’s rate increases began in 2022, bankers might have thought they would have more time to adjust to a new normal.
But that isn’t how things have played out: The Fed has raised interest rates at the fastest pace in decades.
The last comparable episode may be then-Fed Chairman Paul Volcker’s campaign to slay inflation in the early 1980s, before the working lives of most professionals in banking today.
The problem for banks right now isn’t just that some lenders locked up their money in bonds and mortgages at what could prove to be well-below market rates for a long time.
That can be mostly an earnings problem.
And buying Treasurys was in some ways a logical response to regulatory incentives, since they counted as zeros when it came to calculating the risky assets that determine how much equity capital a bank needs.
What turned those moves into fateful mistakes was also failing to contemplate how depositors would react to rising rates.
Even before depositors got skittish about the impact of interest rates on banks’ assets, savers were already seeking out higher rates, with options ranging from money funds to online banks and brokers.
For example, many banks have become accustomed to having a base of deposits that aren’t paid any interest.
These can be things like checking accounts for people and businesses.
These accounts can be inconvenient to move, because customers are using them every day, and they can be a key part of banks’ overall relationships with their customers.
Having these deposits has been seen as a source of strength, and a driver of what is known as “asset sensitivity”—that a bank was more exposed to the benefits of rising interest rates than to their drawbacks.
But noninterest-bearing deposits haven’t always played as big of a role.
Unpaid deposits hovered around just 15% of domestic deposits back in the early 1990s, according to Federal Deposit Insurance Corp. data.
They inched up to 20% in the early 2000s, then jumped to 25% in 2011, during which time many noninterest-bearing deposits were temporarily granted unlimited deposit insurance.
Noninterest-bearing then surged past 30% during the pandemic.
Now those deposits have been falling faster than deposits overall.
Were they to return to the average level as a percentage of domestic deposits from the early 1990s to the present, that could imply a shift of around $1 trillion at today’s levels, potentially adding billions to banks’ collective interest expenses.
Some banks may experience positive changes to their deposit stability or costs from the recent crisis, such as megabanks that customers view as safe havens.
But for investors, trying to figure out which banks are most at risk of deposit shifts or rapid repricing won’t be easy.
Hal Schroeder, a former Financial Accounting Standards Board member and investment manager who teaches accounting at Western Connecticut State University, says investors don’t have quarterly transparency into key things like banks’ continuous estimates of how long different types of deposits will stick around to fund their assets.
“Key information never seems to work its way down to investors,” says Mr. Schroeder.
These risks were much more in focus after the savings-and-loan crisis that began in the 1980s, he added.
“Banking history doesn’t repeat.
But it rhymes.”
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