Competition for deposits is still growing, prompting U.S. banks to raise deposit rates more aggressively.
The Impact of Outflow and Banking Panic in March 2023
The strongest outflow of deposits from the banking system in history, the local banking panic in March 2023 (after the collapse of SVB), and the uneven distribution of deposits in the banking system (skewed towards large banks) are all forcing deposit rates to rise in the face of competition for funding.
Weighted average deposit rates in Q3 2023 are slightly over 2%, compared to 0.5% a year ago.
Historical Patterns in Dollar Liquidity and Deposit Rates
Currently, the quarterly growth rate of weighted average deposit rates is 0.3 percentage points (p.p.), i.e., as deposits are refinanced on new terms, weighted average rates may exceed 2.5% by the end of Q1 2024 (for comparison, in 2007 they amounted to a maximum of 3% at a dollar liquidity cost of about 5%).
In a tightening cycle, the cost of dollar liquidity at the Fed and the interbank level always grows faster than deposits - this is normal. If we take the last 5 tightening cycles: in 1989, the spread between weighted average rates and dollar liquidity was minus 2.7 p.p. at the peak, it was the same in 1995, averaged about minus 2.3 p.p. in 2000 and 2006, and minus 1.6 p.p. in 2019. After that, the spread normalizes.
This time the spread has reached minus 3.5 - 3.6 p.p., which is at least 1 p.p. above normal, and that's over 170 billion of additional interest costs per year (with 280 billion of profit)!
Banks are forced to offer more market-oriented deposit rates, narrowing the gap between bonds and money markets due to the growing liquidity shortage (about 2/3 of the excess liquidity generated in 2020 - 2021 has already been liquidated).
A smoother and slower "run-up" of deposit rates has allowed for maintaining lending rates, supporting the demand for loans and restraining the growth of overdue loans.
The spread between loans and market liquidity is at historic lows and 1 p.p. below the norm for this phase of MPC tightening.
The tipping point has passed - delinquencies will continue to rise, provisioning costs will increase, and banks' margins and profits will decline.
Conclusion
The growing competition for deposits is driving U.S. banks to raise rates aggressively. Factors like the record outflow of deposits in March 2023 and skewed deposit distribution are pushing up weighted average deposit rates. This trend, combined with a widening gap between deposit rates and dollar liquidity costs, is resulting in higher interest expenses for banks.