The SVB collapse has made deposits more valuable than ever — and banks will have to compete for them

Whenever the general public is thinking about bank deposits, something very weird is happening.

The rapid increase in interest rates in the past year — as well as the recent anxiety around the health of America’s regional banks — could put even more pressure on the fundamental profitability of the banking sector. Deposits have become a source of anxiety for the banking system and a potential source of higher-than-expected earnings for bank depositors.

With the failure of Silicon Valley Bank and Signature Bank, and the wavering status of First Republic Bank, deposits have never been more closely examined by depositors or more sought after by many banks.

Not only do banks have to compete more among themselves to secure high-quality deposits from customers who will stick around in times of stress, but they are also facing competition from outside the banking system for customer cash, as high interest rates make a range of non-bank saving instruments more appealing.

“The [Silicon Valley Bank] and [Signature Bank] failures, in addition to other banks with reported deposit outflows, will increase industry competition for deposits,” Morgan Stanley analyst Betsy Graseck wrote in a note to clients.

Overall deposits peaked last summer, according to FDIC data, as high interest rates drew savers to direct purchases of government debt and money market mutual funds. The Federal Reserve on Wednesday raised the interest rate it controls by another quarter percentage point to between 4.75 and 5 percent, which should increase lending costs and deposit yields throughout the financial system.

Typically, as interest rates increase, banks are able to keep deposit rates from growing as fast as loan rates do. This spread between the two makes up the core of how banks make money and, last year, led to healthy earnings in the banking industry’s basic deposit-taking and loan-making business. Income from the interest rates bank paid (largely from deposits) and interest charged (largely on loans) expanded by 31 percent from the end of 2021 to the end of 2022, according to FDIC data.

“Banks have a lot of pricing power in deposits; they’re able to keep deposit rates low, and people don’t leave,” New York University economics professor Alexi Savov told Grid.

This “deposit franchise,” the ability to hold deposit rates down while interest rates rise, can degrade, however. The benefits of higher rates tend to accrue toward the beginning of the rate-hiking-cycle — the Fed began raising rates in March — Morningstar analyst Michael Miller said in an interview.

And if you’re a mid-size bank with lots of uninsured depositors whose neighbors and competitors collapsed as those types of depositors got nervous, the franchise can take a real hit.

Morgan Stanley analysts estimated that about half of First Republic’s deposits were withdrawn from the bank before a consortium of 11 large banks deposited $30 billion with the San Francisco lender. The bank, which actually distinguished itself on offering high rates on savings accounts and certificates of deposits (with a sizable minimum deposit) and low rates on mortgage loans (again, with a hefty required deposit), was already finding itself under pressure as interest rates rose.

The bank’s business model, Morgan Stanley analyst Manan Gosalia wrote in a note, “was supported by its willingness to offer one of the highest rates for deposits and lowest rates for mortgages versus its competition.” In short, if you had enough money to bank with First Republic, you reaped the benefits of high deposit rates and cheap mortgage loans — although the condition of that loan may have been maintaining a certain deposit level with the bank — but that also meant you were less likely to park that money in low-yielding deposits.

This worked because First Republic assumed the deposits would stick around for a long time. That assumption is out the window. The deposit franchise has gone into reverse. Its high-end depositor base — which means a depositor base with lots of deposits above $250,000 — turned into a risk for the bank, the rating agency Moody’s explained, because it means more of a bank’s depositors are liable to flee at the first sign of trouble.

At the end of last year, the bank said it had “experienced rapid migration of deposits to higher-yielding products and asset classes. A prolonged period of high or increasing interest rates may cause us to experience an acceleration of deposit migration, which could adversely affect our liquidity.”

“The savvy saver has been getting more return on their cash,” Greg McBride, chief financial analyst of Bankrate, told Grid.

“Interest rates have been rising over the last year at the fastest pace in 40 years; we have seen a substantial pickup in yields available in various cash investments, from savings accounts to CD and money market funds,” McBride said. “With regard to saving accounts and CDs, there’s a big difference in what’s available depending on whether or not you’re shopping around.”

And those deals have improved. Just in the past two weeks, according to Morgan Stanley data, rates paid to savers for certificates of deposits went up just in the last two weeks, even as expectations for rate hikes moderated.

Deposits have been falling across the industry since this summer, as interest rates have gotten high enough to pull individuals and corporations toward other products that offer low risk but even higher returns.

Many bank executives have noted that as interest rates have risen, their clients with money to move around have moved funds to accounts that have higher rates, like certificates of deposits, or non-savings-account products like money market mutual funds, which take in investor money and buy short-term, extremely low-risk bonds. Retail money market funds have glommed up assets, growing from $1.68 billion at the end of last year to $1.85 billion last week.

“Investors can invest in T-bills, money market funds. And, of course, banks are competing for capital money now. And banks are all in different plays, or some banks started competing heavily,” JPMorgan Chase CEO Jamie Dimon said in the bank’s January earnings call. “We’re going to have [to] change savings rates.”

This turn in the cycle, where savers are demanding higher rates or even abandoning bank deposits entirely, was weighing on First Republic even before it caught contagion from its Bay Area neighbor, Silicon Valley Bank.

Traditionally, debt issued by the government — Treasury bills are Treasury bonds with a maturity of one year or less — has been, at best, difficult to purchase directly from the government, while retail money market accounts are typically available through brokers. The brokerage startup Public, which launched in 2019 and rolled out crypto trading in 2021, launched a Treasury Accounts product with a 4.7 percent yield to the general public this month. The way Treasury Accounts works is it invests customer cash into short-term government bonds and then reinvests as the bonds mature. “The timing was pretty good,” the company’s brokerage head Sam Nofzinger told Grid.

Because the company is a brokerage, not a bank, they had to think of an alternative to a savings account. “What opportunities on the market can we put out there that’s a safe place for emergency funding, with high liquidity and strong current yields?” Nofzinger said. The answer was Treasury bills.

The company wouldn’t release numbers but said 60 percent of accounts had deposited cash into them at least twice, and some of that money has come from savings accounts, as opposed to checking accounts, indicating that some clients are using it for money they want to keep secure.

While the future path of interest rates — and the health of America’s banks — is, as always, uncertain, if rates stay high and bankers feel the need to beef up their deposits, this latest crisis is one where normal people might be able to get something.

“Rates on deposits increase at a slower rate than everything else, and they have a tendency to catch up; the market is expecting deposit rates to catch up,” Miller said.

Bankers’ pain could be depositors’ gain. Whoever said a little competition wasn’t a good thing?