We are now living through a highly unusual economic scenario.
Dubbed a K-shaped recovery by some, a severe economic downturn has arrived hand-in-hand with a sudden and significant inflow of consumer deposits.
The reasons behind this phenomenon are debatable. The broad-brush US approach to government stimulus/relief certainly plays a role, but no bank or credit union leaders saw this coming as PPP funding scenarios began to unfold. The result is a bizarre banking dynamic that’s a far cry from the challenges of recent years. Gone are the days of fighting to grow deposits by more than low single digits per annum. In 2020, it was not unusual for institutions to have registered checking balance growth of 15-25%. One client we’re aware of saw deposits grow unexpectedly by $1 billion.
From a bank or credit union’s perspective, a historic, pandemic-grade deposit influx may be the proverbial good problem to have, but it’s a problem nonetheless.
Deposits can represent a financial institution’s (FI) lifeblood, a necessary foundation to enable lending into the community. But what can banks and credit unions reasonably do with a surplus of it, especially in a down economy?
Putting the Money to Work
The loan-to-deposit ratio is a key metric at many a banker’s annual board meeting. Overlending creates liquidity risk and the potential inability to meet short-term obligations. Under-lending, however, creates a drag on earnings since interest paid on outstanding loans is a primary revenue source.
Prior to 2020, the challenge was to attract sufficient deposits to support loan demand. Virtually overnight, the opposite became true - deposits are plentiful, but loan demand is relatively weak.
The pandemic has also heightened repayment risk for many existing and new loans. Interest rates are also near zero, leaving FIs few good investment alternatives for surplus funds and the challenge of finding productive, profitable uses for these new deposits.
The Tide Comes In; the Tide Goes Out
A new question in this unusual economic climate has arisen: “can FIs count on this abundance of deposits in the long run?” With more government stimulus checks apparently on the horizon, deposits could easily swell further. They could quickly vanish, as well.
Hot money (time deposits like CDs attracted by high-yield promotions) can be at greater risk of departure at maturity in the coming months. What’s more, even short-term expiration dates don’t protect savings and checking account deposits from a sudden outflux.
In these conditions, FI leaders now face generating new loan demand and instating protective measures in case of a sudden run on deposits.
The Bottom Line
FIs with an excess of deposits must strike a delicate balance between generating prudent loan demand and ensuring adequate liquidity – especially if these new balances prove overabundant or temporary.
To date, banks and credit unions have weathered the current economic storm nicely, earning kudos for supporting consumers and small business customers on multiple fronts. The unexpected inflow of deposits is a welcome vote of confidence, but several financial management challenges come with it.
For more about FIs recalibrating for COVID-19, read Long-Term Planning in Short-Term Uncertainty by Larry Pruss.