Banks can defend against the risk of losing deposits in high-interest-rate environments by keeping more liquid funds on hand, new research suggests.
Researchers from New York University and the University of Pennsylvania argue that holding more liquid assets that pay short-term interest rates is an effective way to hedge the risk that depositors will leave when interest rates rise.
"We're saying that [banks] should prepare for that by having more short-term assets on hand to generate the increased income you need for those withdrawals," said Alexi Savov, one of the researchers and an associate professor of finance at NYU.
But banks must be careful not to overdo the strategy, the researchers said. If banks put too much of their holdings in short-term assets and rates fall, they may have difficulty covering their operating costs.
The findings may not come as a surprise to many in the banking industry, who are well aware of the risks associated with deposit franchises that account for more of a bank's value than its assets.
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Looking at a hypothetical bank, the researchers modeled the impact of interest rates on the likelihood that uninsured deposits will experience a bank run.
The researchers also found that financial institutions with deposit bases largely composed of uninsured customer funds are more likely to face bank runs than their peers with higher rates of insured deposits.
That is because when interest rates rise and a bank's value centers on its deposit franchise, that value only has staying power if depositors remain at the bank. That dynamic incentivizes customers with accounts holding funds that exceed the $250,000 Federal Deposit Insurance Corp. limit to leave the bank, the researchers said.
The same incentive doesn't exist for all kinds of deposits, though. The operating balances of commercial and corporate depositors tend to be quite sticky and less prone to bank runs because they are essential to the day-to-day functioning of a company, said Greg Muenzen, director of treasury and balance sheet management at Curinos, a financial services consulting firm.
"Even with your checking account as an individual, you would probably have to spend all day Saturday if you wanted to switch gears because you have automatic bill pay connected for multiple expenses," Muenzen said. "Imagine doing that for a multimillion-dollar company's checking account."
The excess liquidity, or reserves, that businesses park at their banks are more likely to be withdrawn, Muenzen said.
Before Silicon Valley Bank failed on March 10, it ran into trouble partly because it used many of its excess deposits to purchase long-dated securities, a good strategy when rates are low. When short-term interest rates rose quickly in 2022, the value of those long-term securities dropped.
In the two weeks following Silicon Valley Bank's failure, commercial banks saw higher deposit outflows from customers with at least $250,000 than they did from depositors who did not cross that threshold, according to Curinos. But smaller-dollar deposit inflows from consumers who spread out their money helped to offset those declines, Curinos said.
Before they failed, Silicon Valley Bank and Signature Bank had insured deposit rates of 2.7% and 6.2%, respectively, notably lower than some of their big-bank peers.
Other banks with relatively low levels of insured deposits — including First Republic Bank, which reported that 19.8% of its deposits were insured in 2022 — experienced sharp declines in deposits and stock prices last month.
Insured and uninsured deposits typically grow alongside each other, according to the FDIC. But the two deposit types
