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BirdsEye View

 During the pandemic, economic stimulus led to a surge in deposits of close to $4 trillion at its peak around April 2022. That’s a huge number, especially considering that the industry held total deposits of about $14 trillion in October 2019.

While the country’s largest banks were the major benefactors of this surge (they gained $1.7 trillion of the pie, or a rise of 30% of their total deposits), the rising tide elevated all ships. Banks between $100B-$1T gained $1.25T, and banks between $10B-$100 gained only $500B. For a rise of 23% of their total deposits.

Low loan growth led to a deposit glut across the industry for banks of all sizes. Banks used the opportunity to reshape their liabilities by reducing CD rates and reducing the attractiveness of interest-bearing deposits relative to non-interest bearing deposits. The result - an unprecedented percentage of all banks’ deposits moved to core deposit categories.

When the Fed started raising rates, most banks with some notable exceptions had little appetite for deposit growth, and even, in some cases, retention. Deposit strategy was generally aimed at minimizing cost-of-funds impact and maximizing bank margins and profitability. Exception pricing, especially Earnings Credit Rates (ECR), surged to handle those customers who started demanding better returns on their idle funds.

Banks under $10B in assets generally have smaller customers than their larger brethren. As a result, the customers’ alertness to rate differentials was muted relative to larger companies and commercial borrowers. As a result, once the Fed accelerated rate hikes, so did the exodus of deposits from larger banks, with the $10B-$1T population being the most impacted. The largest banks I the land, while experiencing some deposit erosion, also enjoyed the flight to safety we’ve seen during this tumultuous period, and especially so after the SVB liquidity failure. First Republic, which banked primarily ultra high net worth individuals, suffered a similar fate. The deposit runoff we’ve seen since that crisis has occurred primarily in accounts with balances greater than $250,000. Those depositors, both commercial and individual, were looking for better yields combined with improved security.

Also interestingly and predictably, deposit betas varied by the underlying bank strategy, i.e. their need for deposits, rather than asset size.

What have we learned from this unique systemic liquidity cycle? Here is my take:

• Flight to safety is eternal; therefore, any bank other than the largest is at risk of losing a disproportionate share of core funding when liquidity becomes a systemic issue
  
  
• Customers do not forget how their core service providers - bankers, investment managers, doctors etc. - treat them during tough times. It’s an advantage smaller banks have over larger ones. Maximizing bank short-term gains through slow market-adjustment deposit pricing could have longer term negative impacts on your customers’ trust and loyalty
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• Having a stated deposit pricing policy which internally articulates the bank’s desired position relative to market movements has always been a wise move, and more so now. Customers want to know what to expect from their bank in terms of returns. They are less likely to leave if you treat them well, even if your rates are not at the top of the market
  
  
• Liquidity is king, of course. But attracting rate surfers to shore up liquidity is very difficult to unwind when rates stabilize. Be careful about changing your core value proposition to address short-term needs, lest you’ll become hostage to rate-sensitive customers as their percentage of core funding in your balance sheet increases 
   
• Relationships still matter after all. There are limits to customer loyalty, but they also don’t expect you to price at the top of the market either.

The most important lesson, though, is that unprecedented conditions are increasingly becoming the norm. Anticipating them and learning how to make quick but good decisions in a crisis when history provides minimal points of reference if a core competency you must develop to be successful in the future.