Why banks will be slow to raise deposit rates after the Fed hike

Imminent Federal Reserve interest rate hikes won’t find their way into depositors’ pockets right away, with banks expected to keep deposit rates low for at least a few months.

Banks remain awash with cash, so the current state of the industry is trying to increase lending, not attract deposits. Until that picture begins to change, analysts say banks will have little incentive to attract depositors or retain existing ones by offering them higher rates.

“With all this excess cash on bank balance sheets, there’s not a lot of pressure at least for the first two or three rate hikes to drive up deposit costs,” said Peter Winter, banking analyst at Wedbush Securities. .

The Fed is widely expected to raise rates to near-zero levels at its March 15-16 meeting, as part of the central bank’s efforts to bring inflation under control. The rate hikes will help banks charge higher interest rates on their loans, but analysts expect them to be much slower to reprice deposits and offer more attractive rates.

That means bank deposit costs are likely to be significantly lower than they have been in previous cycles, at least for the first few rate hikes, analysts said. Lower deposit costs should help boost bank profits and increase net interest income, or NII, which is the difference between the interest banks earn from loans and the interest they pay to depositors.

Wells Fargo Securities banking analyst Mike Mayo wrote in a note to clients that a major theme for the industry will be “NII skyward.” He expects net interest income to grow at the fastest rate since the mid-1980s.

The large amount of deposits currently held in banks should reduce the need for “deposit battles” where banks compete by offering higher rates, Mayo wrote. He also pointed to efforts by banks over the years to reduce their reliance on the types of deposits most likely to react to rate hikes – and instead focus on stickier and more “core deposits”. less sensitive to rates.

In recent weeks, bankers have pointed to the benefits they expect to see from lower deposit costs compared to previous Fed rate hike cycles.

Jennifer LaClair, chief financial officer of Detroit-based Ally Financial, highlighted the company’s work to increase customer deposits over the past decade rather than relying on more expensive funding sources. “As rates rise, we expect the overall rate paid to be lower this cycle compared to the previous cycle,” LaClair told a Credit Suisse conference last week.

M&T Bank Chief Financial Officer Darren King said last month he expected the Buffalo, New York-based bank to be able to keep deposit costs moderate over the next few months. Fed’s first rate hikes.

“We believe, as do others, that with all the excess deposits in the system and excess liquidity, the responsiveness at least for the first upsides, except for those linked to an index, will be quite low. “, King said. told analysts last month.

Only 5% of M&T deposits are tied to short-term rates and will automatically reprice higher when the Fed raises rates, UBS analyst Erika Najarian wrote in a note to clients. Other large regional banks have similarly small deposits that are pegged to short-term rates, she noted.

Bank of America and Wells Fargo “will likely have the stickiest and least rate-sensitive deposit bases this cycle,” Najarian wrote, while pointing to positive trends at M&T, Alabama-based Regions Financial, and several others. banks.

Analysts still expect the usual competition for deposits to play out over time, but they say the pandemic-induced influx of liquidity into banks will delay the need for rate competition. The sector’s loan-to-deposit ratio stood at around 57% in the fourth quarter of 2021, well below its pre-pandemic level of 72%, according to S&P Global Market Intelligence.

Major banks’ ratios are generally below industry averages, and they’re unlikely to start “deposit price chasing” anytime soon, said Ken Usdin, banking analyst at Jefferies. This should “help the rest of the industry stay low for early bulls,” Usdin said.

Still, some pockets of the industry may come under more pressure, according to Ken Tumin, the creator of DepositAccounts.com. Online certificate of deposit rates have been rising steadily for several months and online savings account rates have started to tickaccording to the DepositAccounts.com tracker.

Barclays, for example, recently increased the rate it pays for its online savings accounts from 0.5% to 0.55%, Tumin said, while Discover Financial Services and American Express have increased their rates. high-yield savings from 0.4% to 0.5%.

Business customers of banks — who put their extra cash in safe assets that earn some cash — should also charge higher rates than typical consumers.

But banks are likely comfortable with some of those corporate deposits moving off their balance sheets, said Jai Sooklal, a partner at consultancy Oliver Wyman. Some banks have already authorized the liquidation of certain business deposits due to the expiry regulatory relief under the additional leverage ratio.

After the Fed allowed that relief to expire last year, making it a little less attractive for banks to hold on to deposits, some big banks took measures aimed at reducing certain corporate deposits.

These steps include eliminating certain corporate clients whose deposits are less stable and more sensitive to rate changes, potentially charging clients who maintain deposits above a certain amount, and encouraging clients to transfer a portion of their deposits in money market funds, Sooklal said.

The Fed’s rate hikes and eventual unwinding of its balance sheet should increase the returns corporate clients can earn on alternatives to bank deposits, such as money market funds and higher-rated portions of mortgage-backed securities. .

At least initially, banks’ excess liquidity will reduce their appetite for higher-yielding alternatives, Sooklal said. This factor will keep banks’ deposit betas – or the extent to which they pass on changes in market interest rates to their depository clients – moderate initially.

That calculus will eventually change, with banks focusing on holding deposits, but when that inflection point will come remains uncertain, Sooklal said.

“When they get to the point where now the ones they didn’t like have gotten away, and now they want to keep the ones that are left, that’s when I think the betas are going to have to start increasing,” Sooklal said.

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