In light of last month’s bank failures, traditional banks and deposit frameworks have come into the spotlight. Customers from regional banks concerned about the safety and availability of their funds made bulk transfers digitally to large banks — a modern day ‘bank run.’

If there was so much concern, why weren’t these deposits already with larger financial institutions?

Deposit interest rates.

Bank of America, JPMorgan Chase, and other top financial institutions in the US pay nearly 0% for on-demand balances held in deposit accounts (such as checking, savings).

This comes at a time when the Fed Funds Rate has catapulted in the last year (above 4%) and is expected to remain at or above its current levels.

Here’s a discussion on the current industry dynamics and what may come next.

RAPID MOVEMENT of retail deposits

In today’s financial services industry, transferring deposits from one bank to another is possible the same day, at anytime, from a mobile device or desktop. Gone are the days of in-person transacting with paper checks or wire transfers at a bank branch — no need for verifying physical IDs, signatures, or transaction history, which was standard practice in the early 2000s. Today’s ease of funds transfer is available from mid-size, regional banks to small credit unions throughout the US.

Business clients (who typically maintain balances above $250K) are a greater risk for deposit fluctuations. Financial institutions that carry higher exposure to specific business verticals are more susceptible to large outflows and liquidity pressure during a downturn (as was the case with Signature Bank and Silicon Valley Bank). For SVB in particular, it was a matter of 2 business days for depositors to request over 35% of total deposits held at the bank (substantially above required thresholds). Small and medium-sized businesses (SMB) deposit volume is no longer as stationary as it used to be.

Adding consumer balances to this equation and it’s clear that financial institutions can’t rely on these deposits to pursue corporate banking and treasury management activities, such as lending and long-term investments. If these money inflows are mostly transactional and can’t be leveraged by banks, then why pay an interest rate on them?

LOW DEPOSIT RATES IN A HIGH RATE ENVIRONMENT?

Interest rates help drive ‘stickiness’' of deposits (i.e. a way of keeping customer balances from leaving the bank). If these balances aren’t being used by banks as an asset for lending or investment activities, then its more of a liability — ultimately, a cost center if interest is being paid out.

Sufficient liquidity is accessible from long-term deposits, debt, and reserve requirements.

This business model is what we see today with large institutions paying close to 0%.

Regional banks do rely on retail deposits from individuals and businesses to generate revenue. It’s common to see promotional offers come in the mail or online for new savings deposits of $10K+. During my time in bank branches (2006 - 2018), customers would bring in ‘coupons’ with bonus offers (e.g. $300 bonus for $25K deposit held for 90 days). Once the promotional period ended and a bonus was paid out, customers would be back to withdraw their funds in a cashiers check.

Underserved customer segments are being passed on by larger banks to smaller competitors. The top financial institutions understand they can’t serve every user and their specific banking & credit needs. For small businesses to grow and thrive, mid-size banks must provide deposit, lending, and other services. This was the case for crypto companies working with Silvergate & Signature Bank, and startups maintaining deposits with Silicon Valley Bank.

BANK RUNs are now bank sprints

As deposit holders lose confidence in their bank, outflows start to come in waves from regional banks to larger financial institutions. Today’s bank run is happening digitally (not in-person) via electronic transfer requests initiated outside of a bank branch. ACH and wire transfers are the payment rails used in rapidly moving funds from one bank to another.

Perception of a bank being in trouble is all that’s needed today — fueled by social media. Individuals take to Twitter and other forums to read posts from influencers or industry leaders. The reaction to negative sentiment starts to snowball as a panic ensues. A bank starts to get flooded with customer requests to empty accounts — all at once.

Even if regulators add more controls and guidelines, the ability to respond in 1-2 days to a bank run (driven by fear) is unlikely. The customer’s impression of their bank as a high risk (yet to be validated) is all that’s needed.

Top financial firms are then inundated with new account requests and pressured to review & onboard applicants quickly. Even if SMBs are granted a deposit account, they should expect a stark contrast in service levels. The direct relationship with a banker may not be as strong — response times to requests may be slower. Approvals for exceptions (such as clearing deposit holds, or fee waivers) would be considered ‘out of policy.’ Unexpected transaction activity (such as a large wire transfer) may be flagged or blocked.

This friction goes back to the previous point — larger banks aren’t set up to deliver the same value as mid-size groups when it comes to certain customer segments. Retail deposits lack priority for top institutions, which is why 4K+ licensed credit unions and mid-size banks exist in the US.

CHANGING THE DYNAMIC

The need for business banking across verticals, from solopreneurs to mid-size companies, won’t go away. With the level of economic activity generated in the small business sector, banks are needed to support these firms with deposit, credit, and other banking services.

Going forward these banks will have increased oversight from regulators, especially in terms of exposure risk to certain sectors. Cryptocurrency seems to be one of the areas scrutinized by various agencies that govern bank policy.

Monitoring by regulators on smaller banks may also change in the near-term to help ensure sufficient capital requirements are maintained. There would need to be a balance between de-risking potential bank runs and allowing banks to use deposits to generate income. Poor investment strategies (and lack of timely adjustments) can also lead to losses, which trigger future concerns of a bank being in trouble.

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