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Small American banks are in a difficult situation: depositors are taking their money elsewhere

Keeping deposit rates close to zero percent for banks is looking less and less sustainable as problems with financial institutions like Silicon Valley Bank, Signature Bank and Silvergate Capital have steered investors toward better and safer forms of savings. Nonetheless yet banks cannot raise deposit ratessince in order to achieve a significant advantage over money market funds, such an increase would be necessary, which would probably have a negative effect on profitability, which would also affect the share price.

The bank bankruptcies have shown that excess cash can be placed in other, safer places, where, in addition, they can get better interest. This trend tends to cause difficulties for smaller banks, as investors consider them less safe.

The deposit portfolio of small credit institutions decreased by 120 billion dollars in the first half of March, while that of the 25 largest banks increased by 67 billion dollars.

Deposit interest rates close to zero were taken for granted by market participants for a long time, but this changed when the Fed’s interest rate hikes caused banks’ costs to rise, and loan interest rates along with it.

However, money market funds were much less affected by the negative effects of the Fed’s interest rate hikes. Today, a record amount, about 5,200 billion dollars accumulated in them, which is forecast to continue. Money market funds park cash in short-term assets, such as Treasury bills, and then pass the returns on to investors. Although concerns about bank failures have eased, investors also in the week of March 29, 66 billion dollars were invested in money market funds. Interestingly, banks that offered higher deposit rates (such as SVB and Signature Bank) collapsed.

A foreseeable negative side effect of withdrawing deposits is that smaller banks may not have sufficient liquidity for lending. Despite this, credit institutions barely compete with money market funds: either they can’t or don’t want to raise deposit interestas they are still saddled with a lot of costs from the low-yielding assets they invested in before the Fed’s rate hikes.

Bank loans are a key resource mainly for small businesses, which are Americans working in the private sector about 46% are employed. According to the FDIC’s 2020 report, commercial banks with less than $10 billion in assets are the

they owned 36% of small business loans, while they only had 15% of loans within the entire sector.

For now, however, it seems that the American authorities have managed to curb the huge deposit withdrawals. The decision of the FDIC, by which it fully compensated the depositors of SVB and Signature Bank, somewhat restored confidence in the banks. However, according to some market participants, these moves can only last for a certain period of time and will continue to take a lot of money out of financial institutions.

It was already clear during the last crisis that the number of deposit withdrawals at banks can increase in crisis situations. In this case, financial institutions rely more on alternative sources, such as the FHLB system, which is a group of 11 state-backed banks that can also make loans to financial institutions. Some have raised deposit rates, however this was not enough to lure clients away from money market funds. In addition, it also reduces the interest margin, which is one of the most important factors in banks’ profitability.

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