The last few days have revealed just how bad the first quarter was for the banking sector. Credit Suisse, which in March collapsed into the arms of its main competitor UBS, recently reported that it had lost $69 billion of customer deposits in the first quarter, bringing the six-month total to an astronomical $225 billion in outflows.
Here in the U.S., First Republic Bank, which in the same month was rescued by a $30 billion cash infusion in the form of secured deposits from eleven of the too-big-to-fail (TBTF) banks, just announced it lost a staggering $104.5 billion of its deposits in the first quarter, representing 35 percent of its total deposit base at the beginning of the year. This surprising revelation once again spooked the equity markets, already jittery from March’s madness. First Republic’s share price is down by over 50 percent on the news, while the NASDAQ Bank Index is down seven percent from last week.
Last week, credit ratings agency Moody’s downgraded eleven regional and other banks, including TBTF contender U.S. Bancorp, which had over $500 billion in deposit liabilities at the end of March. USB was downgraded because of concerns it has a “relatively low capitalization,” partially evidenced by a tangible common equity to tangible assets ratio below five percent, and $7.5 billion in unrealized losses on investment securities.
Systemwide, U.S. banks lost 21.6 percent of their seasonally adjusted total deposits in the month of March compared with the previous year. So far in April, the situation has not improved, with an additional $70 billion of deposits leaving the system. Of the $17.4 trillion of deposits remaining, some $15.5 trillion represents “other deposits,” meaning they are not “sticky” large time deposits that have fixed maturity dates. Rather, these are primarily demand deposits that are subject to the same flight risk that occurred at Silicon Valley Bank, First Republic, Signature, and many others in March. Many of these deposits can be pulled on short notice, as was the case for the tens of billions of dollars that left these banks in a matter of hours.
The collapse of Silicon Valley Bank, Signature Bank and others raised concerns about the overall health of the U.S. banking sector and whether contagion—in the form of additional deposit runs—would spread. However, customers are leaving their banks for a reason that has nothing to do with safety and soundness. Banks are simply not paying customers anywhere near what individuals and businesses can earn, on a similar risk-adjusted basis, outside of the banking system.
According to Bankrate, the national average annual percentage yield for savings accounts is a meagre 0.24 percent. One-year certificates of deposit fare better, averaging 1.7 percent, but banks lock up depositors’ funds for the period. This is all highly unattractive when the yield on one-year Treasuries approaches five percent. According to SEC data, government and Treasury money market funds saw $387.9 billion of net inflows in March. This is not surprising given these funds are yielding over 4.5 percent net of fees, and investors can take their money out on relatively short notice. At some point, the benefit of FDIC insurance (available to bank deposits but not money market funds) is no longer worth the cost of forgone yields. If the Federal Reserve raises interest rates in June by an expected 25 basis points, the gap between bank deposits and money market yields will widen further.
Banks are faced with a dilemma. If they raise yields on their customers’ deposits, they will not be able to adjust asset yields (i.e., on loans and investments) at the same pace and the banks will turn unprofitable. Losses deplete equity capital, which increases insolvency risk and reputational problems. All of this could make investors and depositors nervous, risking further deposit flight and increasing the challenge and cost of raising funding in the capital markets. On the other hand, if the banks don’t raise interest rates on savings accounts and CDs, then the outflow of customer deposits to money markets, Treasuries and elsewhere is likely to continue unabated.
Fitch Ratings recently warned that U.S. banking system reserves may fall by as much as $2.5 trillion by the end of the year as a result of Federal Reserve actions. This large reduction in liquidity would result in tighter credit conditions across the board, from business loans to mortgages, autos, and credit cards. Banks are already reining in their lending activities in anticipation of difficult times ahead.
This is bad news for the U.S. economy. Tighter credit and fewer business loans means weaker economic growth and an increased likelihood of recession. It is possible that this is all part of the plan. In other words, that the intention of the Federal Reserve is to squeeze banking sector liquidity, restraining credit, and thereby forcing a recession in an attempt to break the back of inflation this year. If so, this is a costly and dangerous gamble—with millions of American jobs at stake—that is unlikely to work as planned.
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