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It’s still a wonderful life for some U.S. banks, leaving the greatest uncertainty for those in the middle

Autor: Article based upon analysis from Reuters Breakingviews | Link: For some US banks, it’s still a wonderful life
Timp de citit: 3 minute

Even after a series of financial failures that have sent depositors running for the hills, it’s a good time to be a big U.S. bank. But maybe it’s also a good time to be a small bank. For those sitting in the middle, it’s the worst of all worlds.

Large banks like JPMorgan and Wells Fargo are likely to report that their deposits are down from a year ago when they announce their latest results on Friday.

Along with Bank of America, which is due to report next Tuesday, analysts surveyed by Refinitiv expect they collectively lost about $500 billion in customer deposits.

Deposit runoff is a problem for banks all things considered because customer balances are the cheapest form of funding available, especially because many of them are in transaction accounts that don’t yield interest.

A bank can borrow depositors’ money for free and then lend it out at a profit – a gap known as the net interest margin.

The deposit performance is particularly exciting this quarter, as SVB Financial and Signature Bank were brought down last month by the sudden withdrawal of customer funds.

But the big lenders had already anticipated that some funds would be drained. Bank customers are still sitting on piles of savings created by pandemic-era government stimulus programs and curtailed consumption.

Bank bosses have been warning for two years that those savings would eventually dwindle. By comparison, if deposits at domestic banks had grown at the same rate over the past three years as before the Covid, they’d be $13.5 trillion today, compared with $16 trillion at last count.

Across all banks, deposits are down 5% yearover year; to return to the pre-Covid trend, they’d have to fall 20%.

Even more problematic than the level of deposits is the cost of remaining deposits, which is also rising. Bank managers often say that depositors will look around once interest rates reach 3%.

Yields on 10-year government bonds have been consistently above that threshold since the fall. Depositors will either chase those higher rates by shifting into mutual funds that may be held by a competing bank, or they’ll leave them at the same institution but move into accounts that hold the funds longer but at a higher interest rate.

Both have the same effect on the bank: its funding costs go up, and that squeezes its net interest margin.

Again, the big lenders have some weapons at their disposal. Customers, sluggish at the best of times, are likely to trade some potential interest for knowing that their bank is too big to fail, which is definitely the case with the big lenders.

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This is especially true while the SVB collapse is still in the headlines and lenders that have faltered, such as First Republic Bank, have yet to show signs of lasting stabilization.

Large banks can also offer non-cash perks to their customers. JPMorgan invests $14 billion a year in its technology and has bought dozens of companies to enhance its offerings, from restaurant guide The Infatuation to high-end travel agency Frosch.

Bank of America is promoting its artificial intelligence-powered financial assistant, Erica.

What about the small banks that can’t keep up with these benefits? The reality is that those at the bottom of the banking pyramid are still doing quite well.

Deposits don’t flow out as easily to the smallest lenders as they do to their more impersonal mid-sized regional competitors. Because they’re better entrenched in communities to soothe the nerves of mostly local customers, small banks can build trust and loyalty while reducing anxiety.

Many simply have a geographic advantage, with fewer competitors and less tech-savvy customers. Even though lobby groups and politicians are always complaining about the threat to America’s thousands of community banks, their finances are solid.

Lenders with assets between $300 million and $3 billion earned a 14% return on equity in 2022, compared with about 12% for lenders with more than $10 billion, according to quarterly Call reports filed with the Federal Deposit Insurance Corp.

That advantage for small banks should also shield them from the worst effects of a deposit price war. According to Darling Consulting, which tracks deposit data from community banks and mid-sized regional lenders, they passed on only 23% of the Federal Reserve’s rate hikes to their customers last year.

By comparison, the much larger PNC Financial Services reported about 30% at the end of 2022. In addition, small banks are also less affected by the burdensome regulation resulting from the SVB’s collapse, which will likely focus on lenders with more than $100 billion in total assets.

Not every member of Congress has a megabank in their district, but virtually all of them have a community bank. If these lenders truly go bankrupt, regulators will drop them – but in the meantime, they’ll be given relative freedom.