Lenders are holding onto large piles of cash as insurance against a slowing economy, continuing deposit outflows, and looming more rigid liquidity rules that could particularly impact mid-sized banks. The buildup is another example of a risk-averse approach from a sector still trying to regain its footing after a string of springtime bank failures, which could result in restrained lending.
Since March, the Federal Reserve’s aggressive rate hikes have eroded the value of longer-term assets on bank balance sheets, making some lenders reluctant to sell and put those securities into cash or short-term bonds. That has accelerated withdrawals from bank accounts as people spend money or move it into higher-yielding alternatives, such as Treasuries. Deposit outflows hurt bank profits as they give up the interest income they earned on those deposits. They also force them to pay financial firms more for the deposits that stick around, reducing the benefit to loan profits from higher rates.
For the week ending on March 22, deposit outflows stabilized and slowed slightly for some of the bigger U.S. banks, which reported earnings on Wednesday. The larger 25 institutions lost about $90 billion on a seasonally adjusted basis. Smaller banks, which suffered massive withdrawals in the weeks after regulators seized regional lenders like Silicon Valley Bank and Signature Bank, also saw their outflows stabilize.
The nation’s banking system has roughly $3 trillion in cash. That is considerably higher than the industry’s amount before the pandemic but well below levels that accompanied the last recession and even the Great Depression almost a century ago.
Banks need certain cash reserves to handle customer withdrawals and offset risks such as loan losses from the Federal Reserve’s high-interest rates. However, some regional banks are taking earnings assets out of their earning investment portfolios and shifting them into cash or low-yielding securities to boost liquidity, according to S&P.
The trend has created a new dynamic in the banking industry. While the coronavirus crisis and soaring interest rates have pushed deposit outflows, analysts said broader economic weakness could lead to a more lasting drop in deposits and potentially force some lenders to sell assets at a loss to bolster liquidity. That could further depress the already weak economy and exacerbate the risk of a recession, which is seen as more likely over the next 12 months. A recession would mean more joblessness, reduced spending, and less money available to borrow, a scenario that may push the Fed to cut rates further to stimulate growth. That might be a recipe for more volatility in the stock market, trading near its lowest levels since September 2021. It also might erode confidence in the financial sector and trigger another round of bank failures, similar to those that have rattled the U.S. economy and markets in recent months. The risks from a banking crisis slowdown are complex and uncertain, but they could be just as damaging to the economy as the coronavirus pandemic.