U.S. banks have a streak of rising deposits as a group every year since at least World War II. This year could break it.
Over the past two months, banking analysts have downgraded their expectations for deposit levels in the largest banks. The 24 institutions that make up the KBW Nasdaq Bank Index benchmark are now expected to see a 6% decline in deposits this year. These 24 banks account for nearly 60% of what was $ 19 trillion in deposits in December, according to Federal Deposit Insurance Corp.
While some analysts doubt that the year-round decline will happen, even the possibility would have been unthinkable a few months ago. Bank deposits have grown sharply at unprecedented levels during the pandemic.
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At the end of February, analysts predicted a 3% increase. But analysts have cut $ 1 trillion from their estimates since then, according to a review of FactSet data.
The rapid change in expectations is an important indication of how the Federal Reserve’s growth cycle lands on the financial economy. Forecasts from Fed officials and economists now call for sharp rises in the Fed’s core interest rate to fight inflation. It will wave through the banking industry in countless, somewhat unpredictable ways. How consumers and businesses handle their stored cash will be among the most watched results of the Fed’s action.
“This is by no means traditional Fed austerity – and there are no models that can even remotely give us the answers,” JPMorgan Chase & Co. CEO Jamie Dimon wrote in his annual shareholder letter last week.
A fall is not going to hurt the banks. The flood of deposits had become a headache as it caused large banks to approach the legal limits of their capital. Banks had already pushed many depositors aside because they were unable to make the money act as loans.
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The industry has $ 8.5 trillion more in deposits than loans, according to Barclays analysts. While lending demand is expected to rise and banks need deposits to finance lending, it is more than enough.
“These are deposits they do not really need,” said Barclays analyst Jason Goldberg.
Bank stocks have coincided with changing Fed views. The KBW index started the year on its way higher as the S&P 500 fell. But it has lost almost 20% since mid-January and is now down 9.4% for the year, while the S&P 500 has lost 5.8%.
Banks should benefit from the great benefits of a slow and methodical rise in interest rates. This would allow them to charge more on loans and keep close to zero the amount they pay depositors. After all, banks will not pay more for financing they do not need. That combination would increase what had been record low margins.
The last time the Fed raised interest rates, deposit growth slowed but was still positive, so bankers expected the same.
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But what happened the past two years to set the stage for this year has no precedent. During the pandemic, consumers hid stimulus checks away, and companies stockpiled cash to deal with shutdowns and supply chain problems. Total deposits increased $ 5 trillion, or 35%, over the last two years, according to FDIC data.
Analysts and bankers believe they are unlikely to stay nearby. Citigroup estimates that banks have $ 500 billion to $ 700 billion in excess non-interest-paying deposits that could move quickly.
The most likely recipients are money market funds, short-term investments that often catch crowded deposits from banks.
Historically, consumers and businesses have been slow to move most deposits out of banks to chase interest rates. But the large amount of excess cash floating around could change this behavior, especially if the Fed moves interest rates faster than usual. The Fed is now expected to raise interest rates by half a percentage point at its next meeting instead of the typical increase of a quarter of a percentage point.
“This could lead to more interest rate awareness among consumers,” Deutsche Bank analysts wrote.
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Money market funds began parking the overflow at a recent program at the Federal Reserve Bank of New York for short-term storage. This program, known as the reverse repo, has about $ 1.7 trillion in it now, after it has been largely ignored since its inception in 2013.
Because it’s so new, and suddenly so big, bankers and analysts have been unsure of what will happen to these funds since the Fed began moving interest rates. For months, many saw them as surplus funds that would follow the general idea of ”last in, first out.”
Now some analysts are reversing that theory. They expect money market funds to march their interest rates higher with the Fed, which will keep them more attractive than bank deposits.
The average interest rate on savings accounts was around 0.06% on March 21, according to the FDIC, compared to 0.08% for money market accounts. Savings offices are not expected to move much until demand for loans and deposits returns to balance.
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Demand for the New York Fed program has risen in recent weeks as expectations of major Fed increases have surfaced, said Isfar Munir, a US economist at Citigroup.
“We have had to revise our estimates completely,” said Mr. Munir.