In a decisive move this week, the Federal Reserve conveyed its intention to maintain higher interest rates for an extended period, delivering unwelcome news to beleaguered banks already grappling with escalated funding costs.
This protracted elevation of Federal Reserve rates is anticipated to heighten the strain on certain institutions, compelling them to increasingly rely on costly brokered deposits, colloquially known as “hot money,” sourced from external firms that channel a substantial customer base towards higher-yielding certificates of deposit offered by banks.
While these deposits serve as a vital source of bank funding, especially in a climate where the Fed’s elevated rates prompt customers to seek the most lucrative returns for their investments, they entail a higher cost for banks, thus eroding profits during this challenging phase for numerous financial entities.
According to data from the Federal Deposit Insurance Corporation (FDIC), brokered deposits in the banking sector surged to a staggering $1.2 trillion in the second quarter, marking an 86% surge from the corresponding period the prior year. They now constitute 6.5% of the total US bank deposits, the highest proportion in four years.
As interest rates ascend, Gerard Cassidy, a banking analyst for RBC Capital Markets, affirms, “brokered certificates of deposits and regular certificates of deposits take up a greater percentage of a bank funding base.” This, he asserts, is an immutable reality of the current scenario.
Within the banking sphere, there exists an ongoing discourse about the potential risks associated with brokered deposits. Some contend that new customers may exhibit less loyalty during periods of financial stress, while others argue that this capital can, in fact, be even more steadfast than conventional deposits.
FDIC Chairman Martin Gruenberg highlighted earlier this month, “There has been a significant increase in broker deposits in the banking system over the past year, and they can present liquidity risk.” Regulators possess the authority to restrict or prohibit a bank from accepting brokered deposits if they deem the funding to be inadequately managed.
In a contrasting view, FDIC Vice Chair Travis Hill posited on Thursday that these deposits can also exhibit an “extremely sticky” nature, emphasizing that the customers are fully insured and have no prior relationship with the bank, thus rendering them “indifferent to whether the bank has a future or not.”
The onset of the pandemic saw banks inundated with deposits due to historically low interest rates. Over a span of two years commencing in March 2020, total deposits in the banking sector surged by 34%, reaching $18 trillion.
However, this trend reversed as the Fed commenced its efforts to temper the economy by raising rates, prompting customers to seek out higher yields offered by money market funds. The initial year-over-year deposit decline for all banks materialized at the onset of the second quarter in 2022.
This decline accelerated during the upheaval of the spring, culminating in the failures of Silicon Valley Bank, Signature Bank, and First Republic due to deposit runs, prompting customers to withdraw funds from other regional institutions.
Smaller banks have managed to recover a significant portion of their funds, owing in part to the influx of “hot money.” According to Federal Reserve data as of September 6, banks outside the industry’s top 25 collectively recorded their highest deposit levels since mid-March.
In this context, Western Alliance in Phoenix witnessed its brokered deposits surge to 35% of all deposits in the second quarter, up from 6.5% a year ago. Similarly, Zions in Salt Lake City saw an 11% uptick in brokered deposits during the second quarter, a stark contrast to the year-earlier period when they held none.
Zions Bank CEO Harris Simmons explained, “It was opportunistic in the wake of what’s happened at Silicon Valley Bank,” predicting a substantial reduction in the future.
At regional lenders such as M&T Bank and KeyCorp, concentrations rose by over 5 percentage points, while at Dallas-based Comerica, brokered deposits witnessed a 7% increase. Executives from these banks acknowledged the instrumental role of this funding source in recovering deposits, expressing their intent to transition towards regular deposits.
James Herzog, CEO of Comerica, affirmed, “We are paying for those deposits at competitive rates,” underscoring their satisfaction with the trends in deposit recovery.
This surge in brokered deposits is not limited to mid-sized banks; major banks are also witnessing an uptick. Among the four largest banks in the country, Wells Fargo’s concentration rose from near zero to 6.39%, while Citigroup maintains the highest concentration of brokered deposits among the big four, at 9.54%.
While banks with higher concentrations of brokered deposits may exhibit heightened sensitivity to interest rate fluctuations, experts suggest that, in moderation, they can be a beneficial financial instrument. Feddie Strickland, a bank analyst with Janney Montgomery Scott, posited that, in controlled quantities, brokered deposits are not detrimental to banks.
Source: Yahoo Finance