Could Reduced Loan Demand Cause More Deposits to Leave Banks?

In a recent American Banker article, Stephanie Novosel, head of commercial banking at PNC Financial Services Group stated that “rather than borrowing, some business customers are using the cash built up in recent years to pay for their expansions."

In the same article, Truist Securities analyst, Brandon King, CFA noted that “Companies are doing the math and opting against saddling themselves with loans that carry rates of 7% or higher. Since that cash is coming out of banks' deposit coffers, the outflows are a headache for smaller regional banks that are paying up to retain depositors.”

While higher rates help the loan side of many banks’ asset-sensitive balance sheets, those with substantial fixed rate investment securities portfolios have a different problem. As rates have increased, the unrealized losses on those portfolios have continued to climb.

Some banks now find themselves in a Hobson’s Choice, having to borrow from the Federal Home Loan Banks, the Fed, or elsewhere at rates much higher than they are earning to avoid selling those investments at a loss to meet their liquidity needs. Selling securities at a loss would almost assuredly require an equity raise, something most banks would prefer to avoid. You will recall that the run on Silicon Valley Bank (SVB) earlier this year began after it announced its need to raise capital after selling securities at a loss to meet liquidity needs.

To maintain liquidity, many banks have also turned to high-rate, brokered deposits to replace deposits that have gone elsewhere and are raising their deposit rates to retain balances as customers move from core/non-interest-bearing deposits to higher yielding options.

Banks should immediately identify those depositors who pose the greatest risk of drawing down excess funds and develop a strategy to retain those deposits while also developing a strategy to acquire new, lower-cost deposits. Tools and strategies exist that can help bank executives gain greater control and insight over depositor behavior. While most of the market is currently focused on deposit gathering, smart banking executives will also focus on understanding current depositor motivations.

Remember, deposits are not risk-free and not all deposits are equally valuable to banks.