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Bank deposits have surged over the past four months, giving US financial institutions some much-needed breathing room to insulate their balance sheets against a tide of unrealized losses that wiped out several mid-sized banks in 2023. Deposits are now growing at their fastest annual rate in nineteen months’ time, coinciding with a faster rise in long-term yields compared to their short-term counterparts. That has helped to narrow an ongoing inversion of the yield curve. 

The recent decline in short-term yields could soon be accelerated by expected rate cuts at the Fed, which would likely help banks’ depressed net interest margins recover. Banks’ profitability could be boosted further in quarters to come by a halt to their expansion of loan-loss reserve accounts, which have essentially been on hold since January. Such allowances are made to counter expected losses on loans made by a bank and are recorded as an expense on the quarterly income statement when first provisioned. However, if a bank’s loan book does not perform as badly as expected, they can reallocate these funds from the contra account and count them as profit in the future.

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

Deposits across all US commercial banks jumped to their highest level in more than a year in the final week of March, reaching $17.646 trillion. In fact, the latest week of data represented the strongest YoY increase (2.1%) in deposits since September 2022. The current level of bank deposits is more than $415 billion above a 2023 trough, recouping more than 42% of the net -$981 billion in deposits that flowed out of commercial banks between April 2022 and May 2023. That drought, combined with the unprecedented size of 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 on track to be diminished by some degree throughout the year, concerns regarding deposits and banks’ beaten down bond portfolios should continue to ease.

As we noted in a March breakdown of the FDIC’s most recent quarterly banking profile, covering the final quarter of 2023, pressure on banks’ balance sheets from unrealized losses was whittled down significantly in the latest quarter, thinning from -$683.9 billion in Q3 to -$477.6 billion in the fourth quarter. That represents the lowest level of unrealized losses reported by the FDIC since Q2 2022, helped along by declining mortgage rates and US Treasury yields. Those yields have bounced back in 2024, likely re-inflating unrealized losses on banks’ securities portfolios, but the subsequent rise in deposits shows that demand for withdrawals is not elevated and should help to shield banks from any need to dump securities at large discounts to increase liquidity – part of the fatal mixture behind the failure of Silicon Valley Bank. In fact, S&P Global notes that many banks used improved bond valuations in the fourth quarter to restructure a portion of their securities portfolios without realizing the level of losses they would have previously, increasing their preparedness for another potential ramping up of rates.

Deposits are typically the cheapest source of funds for banks, and they had previously 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 on short-term Treasury bonds throughout 2022 and 2023 created a suction effect on bank deposits, which had been paying little to no interest for many years, leaving clients little incentive to…

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