This month’s newsletter addresses the reported $370 billion decline in bank deposits in Q2 2022, which has kicked up concern in financial circles that the banking industry faces an impending deposit shortage, to explain how most of the change was due to tax payments last April, and that the rest is attributable to management’s ongoing efforts to reduce excess deposits.
Regardless of the efficiencies gained, the industry continues to contend with a glut of liquidity. An example of this glut’s distortive effect on markets and the economy is the short-term money markets, where the Secured Overnight Financing Rate (SOFR) continues to trend through the Fed’s rate on its reverse repo facility.
It also shows up in deposit repricing betas, as bankers continues to observe that these betas have come in below expectations. Part of this may be due to a structural change in deposit behavior toward maintaining higher deposits, shaken by the global financial crisis (GFC) and then COVID.
With the Fed’s quantitative tightening shifting into higher gear this fall, the newsletter discusses management’s optimism that deposits should remain stable and drift higher over time, regardless of the reported Q2 2022 decline.
The piece also looks at the strong loan growth this year, and why banks expect it to stay elevated for some time. Given that there is $7.5 trillion of deposits in excess of loans, bank treasurers are focused on deploying cash, whether in loans or bonds.
Expecting that the Fed will eventually reverse course and cut rates, many banks have increased on- and off-balance sheet efforts to reduce balance sheet asset sensitivity and protect net interest margin.
The Bank Treasury Chart Deck examines how the sharp fall in bond prices and the negative accumulated other comprehensive income at banks that followed in Q2 2022 could have prompted them to shift more of their bond portfolios into held-to-maturity accounts, and this could also be tied to a surge in their advance borrowings.
Highlighting how significant the change in advance balances was in Q2, the deck compares the current surge in advances to other previous surges, such as during 9/11, the GFC, and COVID.
Despite the surge in advances, they still represent a shrinking percent of bank liabilities, and the last slide shows that the industry is still swimming in deposits and has no fundamental need yet to tap its non-deposit sources for additional funding.
After introducing a name change for their show, Ethan and Van look at the latest trend in credit reserves for regional banks that adopted the new current expected credit loss (CECL) accounting that superseded the incurred loss model (ILM) in 2020 just before the pandemic.
The report looks at why the latest numbers show banks shrinking reserves in proportion to their loan books at precisely the time when analysts would expect provision expense at banks to be increasing given rising risks of recession next year.
The duo also compares CECL to ILM, including the former’s higher reliance on models and management judgment, all of which, Ethan argues, results in credit reserve balances that are no more transparent than they were under ILM.
Before they close, Ethan and Van review the history of bank provisions and net charge-offs around the GFC and, before that, during the commercial real estate loan crisis in the late 1980s and early 1990s.