Calm Before the Storm in Deposit Flows?

Euro turmoil has reached its scariest pitch in two years, but deposit levels here in the United States have been relatively stable.

That’s a sharp contrast with last summer, when strains on the Continent combined with the debt-ceiling standoff to send cash flying into transaction accounts at a faster pace than even after the collapse of Lehman Brothers in late 2008.

Maybe the most nervous money has already fled to the shelter of the bank safety net, or maybe tensions are only just building.

Joseph Abate, an analyst at Barclays Capital, sees a case that money markets have been desensitized as fund managers have attempted to wall themselves off from risks posed by European banks. But, he wrote in a report this month, the “binary nature of short-term funding” — its capacity to shut down suddenly and violently — is itself a cause for anxiety.

Year-over-year growth in checking deposits surged to 33% in August 2011, surpassing the previous post-Lehman peak of 29% in December 2008 (see the top chart), as corporations abandoned money market funds with heavy exposure to European banks.

Assets in institutional money funds plunged by $121 billion, or 6.5%, to $1.7 trillion in July and August last year (see the bottom chart). This year, outflows from institutional money funds were only $32 billion, or 2%, from April through June 11 (the most recent data available through the Federal Reserve). That period straddled inconclusive Greek parliamentary elections that stoked fear over the potential breakup of the European currency bloc.

Meanwhile, deposits have also increased fairly gradually in recent months.

Broadly, deposit growth since the financial crisis has been a boon to U.S. banks, providing cheap funding that has helped sustain net interest margins. Panic surges have been nettlesome, however, presenting banks with influxes of money that could stream out as quickly as it arrived, and forcing them to maintain big pools of liquid assets that can produce negative net returns.

More important, the flows reflect systemic funding strains, and the extent of the contagion emanating from Europe’s periphery. The European Central Bank has provided relief to institutions that have been cut off from markets — including about $1.3 trillion of three-year loans in December and March — but money funds are still key creditors to banks in Europe and around the world.

So far, unsecured bank funding rates have held roughly level: yields on wholesale three-month certificates of deposit were only 2 to 4 basis points higher than in April at 32 basis points in mid-June, for instance. Use of the facility the Fed established to provide foreign banks with emergency dollars has also been light, with $24 billion outstanding at June 20, versus $110 billion in February.

Still, strains are apparent in the unwillingness of money funds to lend to French banks for periods longer than a few days, according to Abate. “Unless there is a clear and quick resolution that breaks the sovereign credit-bank capital loop,” he wrote, short-term rates are likely to “break out of their early summer doldrums and move sharply higher.”