The Federal Reserve Bank of New York published a "Liberty Street Economics" blog entry titled, "Deposits and the March 2023 Banking Crisis -- A Retrospective," which explains, "In this post, we evaluate how deposits have evolved over the latter portion of the current monetary policy tightening cycle. We find that while deposit betas have continued to rise, they did not accelerate following the bank runs in March 2023. In addition, while overall deposit funding has remained stable, we find that the banks most affected by the March 2023 events are offering higher deposit rates and are growing their deposit funding relative to the broader banking industry."
Authors Stephan Luck and Matthew Plosser write, "The beginning of 2022 saw unique conditions in the banking sector relative to prior cycles. Deposits and reserves were at their highest levels since the global financial crisis (GFC) of 2007-08, while policy rates were effectively at the zero lower bound. These conditions were in part attributable to the unique nature of the COVID recession and the various forms of government support that sought to minimize disruptions to banks, businesses, and households."
They tell us, "The Federal Reserve embarked on a rapid tightening cycle in March 2022 to counter a significant increase in inflation. By March 2023, interest rate increases had reduced the value of various fixed-rate assets, like securities and mortgages, resulting in substantial unrealized losses in the banking sector. Typically, such losses remain unrealized because banks can hold their fixed-rate assets to maturity since these are funded by relatively fixed, long-maturity liabilities.... In this case, however, several banks experienced depositor flight in response to solvency concerns."
The piece states, "Given these disruptions, there was a risk that pervasive unrealized losses might inspire a revision in depositor behavior that would imperil the broader banking system by forcing additional institutions to raise deposit rates or seek expensive funding to avoid selling assets and realizing interest-rate-related losses."
It also says, "The cost of deposits relative to prevailing interest rates has continued to increase, but the pace of change has appeared stable following the events in March 2023. [A] chart ... depicts the change in overall deposit rates relative to changes in the federal funds rates -- or the cumulative beta -- over the course of the last five tightening cycles for the banking industry. Since 2023:Q1, the cumulative beta of deposits has continued to rise. While the current tightening cycle now resembles those prior to the GFC, there does not appear to have been a sharp change in the progression of deposit pricing following the events in March. Nevertheless, the composition of bank funding has continued to evolve."
The blog continues, "[T]he industry grew substantially during the downturn, with assets up approximately 30 percent through 2021:Q4 relative to 2019:Q2.... The growth in assets was primarily funded by the growth in interest-bearing ... and noninterest-bearing ... deposits. Since 2021:Q4, assets have remained roughly flat: declines in noninterest deposits were offset by a rise in other debt ... such as advances from Federal Home Loan Banks (FHLB) and interest-bearing deposits (including time deposits). These trends appear unchanged following the events of 2023:Q1.... These banks ["super regionals"] experienced large deposit outflows that were mostly directed toward the largest banks (those with assets of at least $250 billion)."
It adds, "The chart below illustrates the evolution of cumulative deposit betas during the current tightening cycle across the distribution of bank size. There are meaningful differences in the cumulative deposit betas, with super-regionals ... being a key outlier. Deposit betas for these institutions have generally been higher than those of smaller banks throughout this tightening cycle.... For the largest banks, betas have been going up at a slower pace than those of other banks. This may reflect the perceived safety of these institutions relative to other banks and is consistent with the flow of deposits to the largest banks around the Silicon Valley Bank episode."
Finally, the piece says, "The events of March 2023 increased the saliency of the sensitivity of deposit funding to macroeconomic and bank-specific conditions. Our review of deposit pricing and funding since that time indicates that the industry appears to have avoided a significant change in depositor behavior that would further pressure earnings and capital. This may in part have been due to government interventions, such as the guarantees extended to depositors and creation of the Bank Term Funding Facility. Further, we document that the deposit pricing of super-regional banks has exhibited a greater sensitivity to rising rates. In line with higher rates, these banks have also grown deposit funding relative to the broader banking industry. In our next post, we will explore the future path of deposit rates given the current neutral stance of monetary policy."
In other news, Wells Fargo's Vanessa McMichael writes in yesterday's "Fixed Income Strategy: Daily short stuff" on "Rates and MMF reform." She comments, "Compared to the start of the year, front-end rates have been relatively stable this month.... Money market fund rates have also remained relatively stable, though they have declined a few basis points YTD across both government and prime categories. Despite the slight retreat in yield, investors are still enjoying rates that are comfortably above 5.0% and are likely to stay that high until the Fed is well within easing. While rates have been a major appeal and discussion topic for MMF investors, compliance dates for the final MMF reform adjustments are nearing. Few corporate and public entity clients have engaged in discussions around the new MMF rules, which is likely because so many exclusively invest in government MMFs and the changes to this category are quite minor in consideration of today's rate environment (converting NAVs to floating or implement RDM in the event of a negative rate environment). Nonetheless, [Tuesday] we partnered with Allspring Global Investments to provide an update on money market fund reform."
The brief says, "The second wave of compliance deadlines that impact investors become effective next week and include an increase in liquidity requirements mandating that funds maintain 25% of portfolio holdings in daily liquid assets and 50% in weekly liquid assets. This is a notable increase compared to the prior 10% and 30% minimums required for prime and tax-exempt MMFs but investors should find comfort in knowing that many, if not most, funds are already able to meet these new requirements. Further, gates and fees that are triggered by a breach of liquid asset levels no longer exist, so if a fund does not have sufficient liquid assets, portfolio managers have to invest in a manner that brings the fund back into compliance. Importantly, with these new liquidity requirements, there is no longer a potential gate that would limit an investor from redeeming nor is there a fee assessed to an investor when redeeming because of the liquidity level."
It explains, "The other rule effective next week is discretionary fees, which are not new, but akin to the prior liquidity fees enacted in 2016. These fees are specific for prime and tax-exempt MMFs and are designed to aid a fund during times of stress, and not serve as a trigger of a breach of the above referenced minimum daily and weekly liquidity mandate. This discretionary fee provides a fund with flexibility should market conditions develop that warrant it. Finally, the last and arguably the biggest rule for the prime and tax-exempt fund space is the mandatory liquidity fees that are effective in October."
Lastly, Wells tells us, "We find that many corporate and public entity investors have largely adopted government MMFs as the primary fund exposure today, so this is likely the reason why we don't hear many questions about the latest MMF reform. Regardless, we think that organizations should review their investment policies for tweaks in language around these new rules and take a look at how current funds will be impacted if any of the rules are implemented, whether for government, prime, or tax-exempt categories."
