Not All Deposits Are Equal Blog Post Apr 2018 David Green Advisors

In the Battle for Deposits, Not Every Bank is a Winner

Bad News for All But the Biggest Banks (or Let Them Eat Cake)

In just a few short years, the vast majority of banks have gone from being flush with low-/no-cost deposits to feeling the pain of an affordable deposit shortfall.  While deposits are up system-wide, the majority of the winners are the biggest banks.  With nationwide footprints, attractive mobile banking platforms and large cash payments to attract new account holders, these institutions have a strong competitive advantage when it comes to attracting valuable retail and commercial transaction accounts.  For the rest, they will be left to feast on high-yield/large balance accounts to fund continued loan growth; such deposits are the equivalent of sugary doughnuts – they taste good going in but they are not really what you can call the foundation of a healthy diet.

For banks that fund marginal loan growth with such low-value deposits (especially when those assets have a non-zero duration), this will almost certainly mean that asset-sensitive risk profiles will quickly become liability-sensitive; the anticipated expansion of net interest margins (in % terms) will not materialize as interest rates continue to increase.

While it’s not too late to hedge the increase in liability sensitivity, the cost to do so has gotten much more expensive in recent months as rate markets have begun to price in several more increases in the Fed Funds rate over the next year.  If ALCO committees have been reluctant to incur the cost to hedge the increase in risk, they are definitely not going to like the price they face now.

It’s kind of like putting off the purchase of hurricane insurance.  It seems foolish to pay premiums on calm, sunny winter days, but if you wait until the fall when a storm is just a couple of days off-shore, you can get coverage, but it’s going to cost you an extraordinary amount of money.  At some point, you have to bite the bullet either way – pay the large premium or pray that the damage from the storm won’t bankrupt you.

Expect more and more more banks to take the latter position; rising deposit costs have already begun to challenge budget targets so expensive insurance premiums will simply not get paid.  With unemployment at record lows, oil at multi-year highs and trade battles brewing, the threat of inflation looms large.  We can only wonder if the storm will be a category 4 or category 5.