U.S. REGIONAL BANKS REDUCED CASH BUFFERS AHEAD OF RUN ON DEPOSITS / THE FINANCIAL TIMES

US regional banks reduced cash buffers ahead of run on deposits

Lenders were left unprepared for mass withdrawals as they adjusted to rising interest rates

Stephen Gandel in New York

Small cash piles left the likes of Silicon Valley and Signature vulnerable to deposit outflows © FT montage/Bloomberg

The largest US regional banks began this year with less cash on hand than at any time since the 2008 financial crisis, leaving them ill-prepared for a rush of deposit withdrawals that led to the collapse of Silicon Valley Bank and Signature Bank.

As they adapted to rising interest rates, the 30 banks with assets between $50bn and $250bn cut the percentage of their assets held in cash to an average 7 per cent at the start of 2023, from 13 per cent a year before, according to Federal Deposit Insurance Corporation data.

That was less than half the cash held by the nation’s largest and more strictly regulated lenders, such as Citigroup and JPMorgan Chase, which on average had 15 per cent of their assets in cash.

The small cash piles left regional banks including SVB and Signature, which failed last month, vulnerable to deposit outflows and the risk that they would be destabilised by losses on forced sales of their securities to give customers back their cash.

“What was your available cash was certainly something investors were looking at,” said Josh Rosner, an independent banking analyst and managing director of Graham Fisher & Co. “It absolutely augmented” the panic in bank stocks, he added.

The low levels of cash marked a sharp drop from the first year of the pandemic when US government assistance and reduced consumer spending led to a nationwide jump in cash deposits. 

Regional banks last year drew down their cash to make loans and invest it in bonds and other securities.

For instance, SVB’s cash holdings as a share of total assets dropped from $22bn, or 14 per cent, in mid-2021 to $12bn, or just 6 per cent, in early 2023. 

Over the same period, its bond portfolio rose from $83bn to $117bn and its loans rose from $50bn to $72bn.

“As the [Federal Reserve] set out to fight inflation, it got tough for smaller banks to find profits,” said Scott Hildenbrand, chief balance sheet strategist at bank advisory firm Piper Sandler. 

The answer for many small banks, he said, was to move assets that they had been holding in cash, earning nothing, into bonds that paid modest interest income. 

But this risked losses should the bank actually need those funds to repay depositors, something that had not been a concern for years — until it suddenly was.

When more and more SVB depositors began asking for their money back last year, the bank found itself short of cash to meet their demands. 

So SVB decided to sell some bonds at a $1.8bn loss. 

Those losses spooked investors, and the bank quickly unravelled.

Analysts and banking industry consultants point to a number of reasons for that drop in cash.

The first is the Fed. 

Smaller banks make more of their money from the difference between short-term and long-term interest rates, as they get less fee revenue than big banks from investment banking, asset management or credit cards.

The Fed’s rate increases squeezed that so-called spread income last year, forcing regional and community banks to put more and more of their cash to work in order to generate the same level of profits. 

In all, the larger regional banks collectively cut their cash holdings by half last year.

Experts believe regulation played a role as well. 

After the financial crisis, banks were required to hold more of their assets in cash. 

The new liquidity rules effectively forced most of the nation’s large and midsized banks — those with more than $50bn in assets — to hold more than 10 per cent of their assets and deposits in cash, more than double what most banks had going into the financial crisis.

That is where cash levels stayed until lawmakers voted in 2018 to loosen regulations for banks with less than $250bn in assets. 

After that, cash levels at regional banks with $50bn to $250bn began to fall.

That lack of cash has now become a major issue for regional banks well beyond SVB and Signature.

First Republic, which entered 2023 with just 2 per cent of its assets in cash, experienced large deposit outflows after SVB failed and its shares plunged 90 per cent. 

Ultimately, 11 of the nation’s largest banks agreed to deposit $30bn in cash with the California-based bank, stabilising its share price.

Western Alliance Bank had just $1bn in cash at the beginning of 2023, just 1.5 per cent of its $67bn in deposits. 

Its shares have dropped by half in the past month. 

Shares of KeyCorp, which started this year with just over $3bn in cash, or less than 2 per cent of its $188bn of its deposits, are down 30 per cent this month.

Citigroup, on the other hand, had nearly 25 per cent of its deposits in cash at the end of last year, the most out of any of the large banks. 

Its stock fell a relatively modest 10 per cent in March.

“A lot of banks are doing what they can to make sure their cash positions look sufficient when their financials come out at the end of quarter,” said Hildenbrand. 

“They are fighting a perception, and no one wants to be the bank people are worried about.”