CAUGHT BETWEEN LEAKING DEPOSITS AND UNREALIZED LOSSES

Pre-pandemic, availability and the cost of funding were the greatest challenges for banks. Banks had to increase the rate on deposits and their dependency on wholesale funding. Total deposits (checking accounts + money market deposits + CDs + savings) increased 4.7% in the U.S. in 2019.

The pandemic brought in a rush of deposits. These could be traced mainly to distribution of federal stimulus and a slowdown in spending. Total deposits increased by more than 20% in 2020. Then from September 2021 onward, deposits growth slowed and spending resumed. However, banks continued to have large reserves of low-cost funding.

Loan demand has not kept up with the deposit influx. Industry-wise, the LTD ratio fell from 80% at the end of 2019 to 63% by mid-2021. For community banks, it fell from 85% to 74%. That induced banks to find other forms of riskier investments to deploy their extra liquidity. This can be precarious due to the uncertain economic environment and a lack of expertise in smaller banks. Deposit betas (the measure of repricing sensitivity for an increase in funding costs) are rising. This poses a risk for smaller banks, in contrast to the largest banks with a national reach, who traditionally benefit from significant customer inertia, large volumes of depositors and many dormant savings and checking accounts.