The Federal Reserve’s looming interest rate hikes won’t find their way into depositors’ pockets right away, with banks expected to keep deposit rates low for at least a few months.
Banks remain flooded with liquidity, so the industry’s current predicament is trying to grow loans, not attract deposits. Until that picture starts to shift, analysts say banks will have little incentive to lure depositors or retain existing ones by offering them higher rates.
“With all this excess cash on bank balance sheets, there's not a lot of pressure at least for the first two or three rate hikes to increase deposit costs,” said Peter Winter, a bank analyst at Wedbush Securities.
The Fed is widely expected to raise rates from near-zero levels at its March 15-16 meeting, part of the central bank’s efforts to tame inflation. Rate hikes will help banks charge higher interest rates on their loans, but analysts expect they will be far slower to reprice their deposits and offer more attractive rates.
That means banks’ deposit costs will likely be significantly lower than they have been in past cycles, at least for the first few rate hikes, analysts say. The lower deposit costs should help boost bank profits and widen their net interest income, or NII, which is the difference between the interest that banks make from loans and the interest they pay to depositors.
Mike Mayo, a bank analyst at Wells Fargo Securities, wrote in a note to clients that a major theme for the industry will be “NII to the sky.” He expects net interest income to rise at the fastest pace since the mid-1980s.
The vast amount of deposits currently sitting at banks should reduce the need for “deposit battles” where banks compete with each other by offering higher rates, Mayo wrote. He also pointed to banks’ efforts over the years to lower their reliance on the types of deposits that are more prone to respond to rate increases — and instead focus on stickier and less rate-sensitive “core deposits.”
In recent weeks, bankers have highlighted the benefits they expect to see from lower deposit costs compared with past Fed rate hike cycles.
Jennifer LaClair, chief financial officer at Detroit-based Ally Financial, pointed to the company’s work to grow customer deposits over the past decade rather than rely on more expensive sources of funding. “As rates rise, we would expect the overall rate paid to be lower this cycle than last cycle,” LaClair said at a Credit Suisse conference last week.
M&T Bank CFO Darren King said last month that he expects the Buffalo, New York-based bank will be able to keep deposit costs subdued amid the first few Fed rate hikes.
“We believe, much like others, that with all the excess deposits in the system and excess liquidity that the reactivity at least for the first few hikes, with the exception of those that are tied to an index, will be pretty low,” King told analysts last month.
Only 5% of M&T’s deposits are tied to short-term rates and will automatically reprice upward when the Fed hikes rates, UBS analyst Erika Najarian wrote in a note to clients. Other large and regional banks have similarly small amounts of deposits that are indexed to short-term rates, she noted.
Bank of America and Wells Fargo “will likely have the stickiest and least rate-sensitive deposit bases in this cycle,” Najarian wrote, while also flagging positive trends at M&T, Alabama-based Regions Financial and several other banks.
Analysts still expect the usual competition for deposits to unfold eventually, but they say the pandemic-driven flood of liquidity at banks will delay the need for rate competition. The industry’s loan-to-deposit ratio stood at roughly 57% in the fourth quarter of 2021, far below its prepandemic level of 72%, according to S&P Global Market Intelligence.
Bigger banks’ ratios are generally lower than industry averages, and they are unlikely to start “chasing deposit pricing up” anytime soon, said Ken Usdin, a bank analyst at Jefferies. That should “help the rest of the industry stay low for the first few hikes,” Usdin said.
Still, some pockets of the industry may see more pressure, according to Ken Tumin, the creator of DepositAccounts.com. Rates on online certificates of deposit have been rising gradually for several months, and rates on online savings accounts have
Barclays, for example, recently raised the rate it pays for its online savings accounts from 0.5% to 0.55%, Tumin said, while Discover Financial Services and American Express raised their high-yield savings rates from 0.4% to 0.5%.
Banks’ corporate clients — which park their extra cash in safe assets that make a bit of money — are also expected to demand higher rates than typical consumers.
But banks are likely comfortable with some of those corporate deposits running off their balance sheet, said Jai Sooklal, a partner at the consulting firm Oliver Wyman. Certain banks have already been allowing some corporate deposits to run off due to the
After the Fed allowed that relief to lapse last year, which made it slightly less attractive for banks to hold onto deposits, some bigger banks have taken
Those steps include weeding out some corporate clients whose deposits are less stable and more sensitive to rate changes, potentially charging clients that maintain deposits above a certain amount and encouraging clients to move some of their deposits into money market funds, Sooklal said.
The Fed’s rate hikes and the eventual unwinding of its balance sheet are expected to raise the yields that corporate clients can earn on alternatives to bank deposits, such as money market funds and the highest rated portions of mortgage-backed securities.
At least initially, banks’ excess liquidity will reduce their appetite for matching the higher-yielding alternatives, Sooklal said. That factor will keep banks’ deposit betas — or the degree to which they pass market interest rate changes along to their deposit customers — subdued initially.
That calculation will eventually change, with banks shifting their focus to retaining deposits, but when that inflection point will come remains unclear, Sooklal said.
“When they get to the point where now the ones they didn't value have run off, and now they want to keep those remaining ones, that's when I think betas are going to have to start rising,” Sooklal said.
