Bank Deposits Back on the Rise as Falling Rates Cut Unrealized Losses, Steepen Yield Curve

US commercial bank deposits jumped to their highest level in 10 months in the most recent data available, reversing a portion of the massive decline in account balances seen throughout 2022 and 2023. Part of that can be chalked up to a slowdown in assets flowing into money market funds and other cash equivalent assets. Long-term yields have fallen over the course of the past few months, reducing unrealized losses on banks’ available for sale and held to maturity securities, while a simultaneous decline in rates at the short end of the yield curve has recently helped to increase its steepness. 

These are all positive prospects for America’s banking sector, which nearly entered a crisis last year after three of the four largest bank failures in US history threatened contagion. Several of the largest depositories are now leading the charge on record-breaking bond sales to start the year, suggesting strong demand for their debt among creditors. Banks do appear to be somewhat concerned with the health of their loan books, building up significant contra account balances to prepare for any future losses, but if economic growth remains resilient, these reserves could later be reclaimed as billions of Dollars in profit. 

Related ETF: SPDR S&P Bank ETF (KBE)

In the week to January 17, commercial bank deposits in the US touched a 10-month high at $17.438 trillion, more than $200 billion above a 2023 trough. That has helped banks to recoup out about a fifth of the nearly -$975 billion of deposits drawn down from bank accounts between April 2022 and May 2023. That drought, combined with unprecedented unrealized losses on bank balance sheets, ultimately led to three of the four largest US bank failures in history last year. However, with short-term interest rates set to be diminished throughout the year, pressure on deposits and banks’ beaten down bond portfolios could continue to ease.

The drain on bank deposits in 2022 and 2023 was primarily induced by relatively advantageous yields on cash equivalent investments like Treasury bills after the US Federal Reserve began aggressively increasing its benchmark Fed Funds rate. A 525bps gain in the upper limit on that overnight rate throughout the past two years helped push the annualized yield on other short-term debt like a 3-month US Treasury bill to as much as 5.6%, a level unseen in more than two decades. This created a suction effect on bank deposits, which had been paying little to no interest for many years, leaving clients little incentive to leave their cash in bank accounts.

Deposits are typically the cheapest source of funds for banks, and they grew massively in 2020 and 2021 amid a zero-rate environment and significant quantitative easing at the Fed. But as MRP has previously noted, higher rates meant banks were forced to increase their deposit rates throughout 2023 to compete with cash equivalent investments and stem the tide of outflows from deposit accounts that threatened many institutions’ solvency. An increase in costs for deposits meant a narrowing of banks’ net interest margins (NIMs), which measure…