MNI INTERVIEW: Deposits To Continue To Leave US Banks-Schnabl

Deposits at U.S. commercial banks will continue to slip lower as the Federal Reserve leaves rates high and the March bank crisis lifted funding costs for banks permanently, said New York University Stern School of Business Professor Philipp Schnabl in an interview.

"I would expect more outflows. As long as we have higher rates we tend to see that this will continue," said Schnabl, a former New York Fed visiting scholar.

So far the core deposit outflows are roughly in line with past estimates, he said, pointing to his 2016 paper with co-authors.

Given the average deposit spread beta of 0.61, a 100 bp increase in the fed funds rate is expected to induce a 365 bps outflow of deposits and a 249 bps reduction in lending. These estimates imply that a typical 400 bps Fed hiking cycle induces a 1,458 bps reduction in deposits and a 995 bps reduction in lending relative to keeping rates unchanged, he said.

"It remains to be seen how this will play out over the entire hiking cycle," said Schnabl, who presented on banks, nonbanks, and interest rates at a recent Atlanta Fed conference. Based on 2014 figures, these numbers translate into over USD1.3 trillion reduction in deposits and nearly USD800 billion less in lending.

The Fed in early May raised borrowing costs by another 25 basis points to a range of 5% to 5.25%. Officials have appeared divided on a June hike or pause while others have suggested a potential skip to a July hike. (See: MNI INTERVIEW: Fed Seen Pausing In June, Could Restart-Acharya)

FUNDAMENTAL RESET

Fed officials have said conditions in the banking sector had broadly improved since early March, with the initial deposit outflows experienced by some regional and smaller banks moderating substantially over subsequent weeks.

Around USD980 billion in deposits have left banks since the Fed began to raise interest rates, the biggest outflow on record, with over USD670 billion of inflows into money market funds during this Fed hiking cycle about half of that since SVB failed. Deposits have stabilized since late March, but the sector is still stressed as evidenced by still-high Fed loans to banks, weak bank lending, and declines in the share prices of US regional banks.

To some degree, there has been a fundamental reset with a subset of depositors who have left banks and moved to money market funds and large banks, Schnabl said. "Chances are they are not going back to the regional banks and there will be a bit of a reset in terms of thinking about these banks' business model."

Ongoing funding pressures on U.S. banks are visible in still-heavy lending to banks by the Federal Reserve, currently totaling USD305 billion or around 1.5% of US GDP. This includes all lending facilities such as the discount window and the new bank term funding program. The Fed lending has edged down from its March peak but is still around half the level seen at the peak of the global financial crisis.