While there has been a lot of concern that a deposit run on small banks would put them out of business, a little history provides important context to their circumstances.
Small Banks’ Bond Investments and Fed Rate Hikes: Impact on Deposits and Borrowing
- The table below provides a good indication of how much deposits have grown at small banks since covid, as Americans apparently felt safer with their money in bank deposits (no matter how low yielding) relative to the uncertain stock market.
- In turn, small banks invested these deposits into safe government backed bonds which, no matter how low yielding, were profitable given a small yield premium compared to the zero-funding cost of their deposit base. This investment decision reflected a higher demand for deposits relative to loans, indicative of a country reeling from covid lockdowns.
- In any case, Fed rate hikes caused the value of these bond portfolios to plummet. Fortunately, the small banks were able to bring the bonds to the Fed as collateral for loans (borrowing below) at full par value (essentially wiping out their bond losses).
- What is interesting from the data below is that deposits at the small banks have only decreased by -4% during the year-to-date (YTD) period ending 4/5/23. Notably, this is not very traumatic and hardly qualifies as a loss of confidence in these depository institutions.