The Brookings Institution published an update titled, "The evolution of banking in the 21st century," which summarizes, "Uninsured deposits should be subjected to tougher regulatory requirements to guard against the type of rapid runs that toppled three large regional banks last spring, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 29. In the wake of the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank (three of the four largest bank failures in U.S. history), the authors look at two trends over the past quarter century -- the substantial growth of uninsured deposits and the migration of business lending to non-banks. The trends challenged the failed banks and banks like them, and in some cases left them vulnerable to runs. And, using a simple model they constructed, the authors assess regulatory options for reducing the risk of destabilizing runs."
Authors Samuel Hanson, Victoria Ivashina, Laura Nicolae, Jeremy Stein, Adi Sunderam, and Daniel Tarullo, all from Harvard University, comment, "One of the most striking developments that we document ... is a dramatic growth in the economy-wide ratio of bank deposits to GDP [gross domestic product], with much of this growth coming from large uninsured deposits."
The brief explains, "According to their paper -- 'The Evolution of Banking in the 21st Century: Evidence and Regulatory Implications' -- total deposits in the fourth quarter of 1995 were 49% of GDP, with 20% of those deposits uninsured. By the third quarter of 2023, total deposits were 75% of GDP, 39% of them uninsured. Adding to that vulnerability, technology and social media have made it increasingly easier for large depositors to quickly withdraw their money."
It says, "Meanwhile, banks with the most rapid growth in deposits have seen the biggest declines in business lending, which has migrated toward non-bank entities such as securitization vehicles, mutual funds, insurance companies, and, in recent years, private-credit funds and business development companies.... Instead of lending to large- and medium-size businesses, regional banks have shifted toward investing in longer-term Treasury securities and government-guaranteed mortgage backed securities. Those securities have little or no credit risk (the risk of default) but they are subject to interest-rate risk. When interest rates rise sharply, as they did in 2022 when the Federal Reserve raised rates to fight inflation, existing long-term securities lose value because investors can earn more from newly issued securities."
The update tells us, "To reduce the risk of runs, the authors looked at expanding federal deposit insurance to cover all or most deposits. But that expansion of the government's footprint would increase taxpayer exposure and could weaken banks' incentives to guard against risk. Also, in the case of banks that have shifted away from lending, it would in effect subsidize bond holding rather than lending."
It adds, "Instead, the authors favor strengthening liquidity regulations, which aim to ensure banks have funds available to meet deposit withdrawals. The authors would require banks with more than $100 billion in assets to back their uninsured deposits by pre-positioning collateral, largely in the form of short-term government securities, at the Federal Reserve. That requirement would enable them to withstand a run by borrowing from the Fed's discount window and would encourage them to shift their asset-mix away from longer-term securities and toward short-term securities, which are much less subject to interest-rate risk."
Finally, the summary says, "The authors also recommend that regulators re-think rules that, except for the eight largest U.S. banks, shield regulatory capital from reflecting most market losses on the securities banks hold. And, the authors recommend that regulators 'look more positively on proposed mergers of mid-size regionals and on acquisitions of smaller banks by mid-sized regionals.' That could either help regionals to better compete with the largest banks or could aid in wringing out excess capacity to the extent that the business model of the regionals continues to be under pressure."
In related news, the website DepositAccounts.com published the brief, "Deposit Account Holders Netted 5.25 Times More Interest in 2023 Than in 2022." It states, "The past couple of years have been good to depositors, with interest rates rising and fees falling. And 2023, in particular, was good to bank account holders. In fact, those with deposit accounts netted 5.25 times more in interest than in 2022."
The blog states, "Banks paid out $315.4 billion to domestic deposit accounts in 2023, according to our analysis of quarterly Federal Deposit Insurance Corp. (FDIC) filings. This contrasts sharply with the $78.7 billion paid out in 2022. That equates to a year-over-year increase of 301.0%.... Each deposit account earned an average of $440.54 in 2023, 384.2% more than an average of $90.99 in 2022. These deposit accounts include demand deposit accounts (such as checking accounts), savings deposit accounts, time deposits (such as certificates of deposit) and certain retirement savings accounts."
It also says, "By quarter in 2023, accounts went from earning an average of $84.02 in interest in the first quarter to $132.59 in the fourth quarter.... That increase is part of a larger trend: In last year's deposit account interest study, we found that banks paid out 223.1% more in interest in 2022 than in 2021."
The piece quotes DepositAccounts founder Ken Tumin, "The Fed raised its benchmark interest rate in 2022 by 425 basis points, the largest annual increase since 1980.... Most of the increases came in the second half of 2022, and banks took some time before they increased deposit rates based on Fed rate increases. Thus, most of the impact of the Fed interest rate increases on deposit rates came in 2023."
Separately, Federated Hermes' latest monthly update from Money Market CIO Deborah Cunningham is titled, "Investing in the now: The Fed is not feeling pressure to cut rates." It says, "The Federal Reserve will eventually lower rates, but based on the March FOMC meeting, that is down the road. The situation means this remarkable period in cash management history could stretch for many more months, keeping yields attractive and assets growing."
Cunningham writes, "[The] supply of Treasuries might be a little tighter in the second quarter as the U.S. Treasury receives tax payments, but that should not have a material impact. Speaking of taxes, the tax-adjusted value of municipal money funds across the industry for those in the top tax brackets is compelling, and SIFMA has been less volatile of late."
She adds, "A final reminder that the next compliance stage of the new SEC money market rules arrives tomorrow. Money funds must maintain at least 25% in daily liquid assets (previously 10%) and at least 50% in weekly liquid assets (previously 30%). Tax-exempt money funds are not subject to the daily requirement."
