An increase in U.S. commercial banks' borrowings suggests they're uncomfortable losing any more reserves as depositors seek better returns elsewhere, according to Citigroup analysts.
After declines in June and July, the largest U.S. banks increased their borrowing in August by 9%, or $70 billion, Federal Reserve data shows. Concurrently, the Federal Home Loan Bank System, a general liquidity provider for banks, saw total debt outstanding rise to $1.249 trillion from $1.245 trillion in July.
Depositors have been leaving banks of all sizes since the Federal Reserve started raising interest rates 18 months ago, leading to the emergence of higher-yielding alternatives. The outflows peaked in March when Silicon Valley Bank and several other institutions failed. While the turmoil has abated, cash is still leaving. Bank reserves also face pressure from growth in borrowing by the U.S. government in the form of Treasury securities.
The increase in borrowing by large banks indicates that they "are not comfortable letting reserves fall much further from current levels," Citi strategists Shuo Li and Jason Williams say in a report.
Wall Street strategists have estimated the banking system's aggregate lowest comfortable level of reserves is somewhere around $2.5 trillion. Scarcity has caused problems in the past, most notably in September 2019, when the Treasury increased borrowing and the Fed stopped buying as many Treasuries for its balance sheet.
Between the turmoil in March and uncertainty surrounding the Basel III reforms, banks are motivated to hold more reserves than they may actually need and lean more on the Home Loan banks.
The Fed's most recent survey of financial offers published in August showed that roughly 79% of respondents said their institutions preferred to hold additional reserves above the lowest comfortable level. Nearly half of those respondents also reported increased borrowing from FHLBs as the result of the banking system stress in March.
Home Loan bank advances currently account for over 45% of banks borrowing, the highest level since 2006, excluding the fourth quarter of 2022 and first quarter of 2023, according to Citi.
"Despite this fact, we still think there's plenty of room left for banks to further increase their borrowing from FHLB advances," they wrote. That has downstream effects for investors in short-term debt such as Treasury bills, to the extent that Home Loan bank issues more to meet bank demand for advances.
