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The banks do not seem to have developed more comprehensive relationships with new deposit customers, but the costs of deposits lag behind the interest rate increases.

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Deposits in the US banking system grew steadily for most of 2019, but when the pandemic hit, it flooded the system to unprecedented levels. Much of that can be attributed to investors turning to cash to avoid risky assets during the pandemic, as well as Americans saving more when there wasn’t much to do. Trillions of dollars in federal government stimulus only increased deposits.

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With the effects of the pandemic easing in the US and gross domestic product expected to grow 7% this year, many analysts and investors are trying to figure out how sticky the massive deposit flow will be once the spending is in place and whether the money will be spent as soon as it is removed it is coming. But there are good reasons to believe that excess liquidity could be here for a while. Here’s why.

Banks have seen an extraordinary amount of deposits flow into the banking system: As of May 26, commercial banks in the United States had approximately $17.09 trillion in deposits.

Part of this is likely due to trillions of dollars in stimulus from the federal government, along with the fact that America’s personal savings rate was around 33% in early 2020 and around 28% in early 2020. 2021. Also through quantitative easing, the Federal Reserve is buying all kinds of assets (such as certain securities to keep interest rates low) and increases the money supply, which has also contributed to excess deposits, especially to the big banks.

The big question is how much of that money will be left now that things are back to normal? It’s hard to know for sure, but deposits have remained high as consumers begin to taper off stimulants.

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Wells Fargo CEO Charlie Scharf said on a recent conference call that about two-thirds of the estimated $48 billion that poured into consumer bank accounts during the second and third rounds of the stimulus had been spent. Bank of America CEO Brian Moynihan also said recently that consumers spent about 30% to 35% of the stimulus money, so there is some evidence that high deposit levels are not strictly linked to the stimulus.

Banking is a relationship business, and banks are always trying to better serve the customer by cross-selling other products, so what started as a deposit relationship can turn into a mortgage or wealth management relationship. The banks also found many new business customers through the Paycheck Protection Program and were able to convert them into full banking relationships. While I’m sure a decline in current inventory levels is inevitable, I think levels will remain high for some time relative to where they were before the pandemic.

Another event that will test the strength of deposits is when the Federal Reserve raises its benchmark federal funds rate, which affects the interest rates banks charge on loans and pay on deposits. Depending on your views on inflation, the Fed will raise interest rates in 2022, 2023 or 2024, with no exact timetable.

The good news is that deposit costs are lagging behind rate hikes, so deposit costs are unlikely to rise as soon as the Fed raises rates. Banks start raising interest rates on deposits when they leave the bank to get better returns on deposits elsewhere. The value of deposits lags behind higher interest rates because the banks generally believe that many customers will not leave at the first sign of a rise in interest rates.

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There are certainly some types of deposits, such as municipal deposits, which are very sensitive to rates, but low-cost consumer deposits last a while. JPMorgan Chase COO Gordon Smith recently offered some insight into what happened the last time rates started rising around 2016 and 2017:

If you look at the last cycle, we saw prices go up, they went up about 175 basis points (1.75%) before prices started to move. It was huge. Will that be true in the future? Maybe not exactly, but I think we’re going to see prices go up and stay relatively stable at 175 basis points, at least for a period of time.

This is certainly significant, and if you compare the cost of deposits at JPMorgan, the largest US bank by assets, to the federal funds rate, you can clearly see that the cost of deposits is slower than the Fed rate hikes.

The last set of rate hikes occurred between late 2015 and January 2019, going from 0.12% to 2.40%. In the same period, JPMorgan’s cost of interest-bearing deposits rose from 0.13% to around 0.80%. While the federal funds rate rose 2.28% during that period, the cost of interest-bearing deposits at JPMorgan rose 0.67%.

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Deposit franchise is a closely watched metric among banking investors. Banks with strong, low-cost deposit franchises often attract high valuations and high share prices.

High-quality deposits allow banks to fund lending growth in a rising interest rate environment and increase their profit margins as deposit costs remain low and lending rates rise. The gap between deposits and interest is good news. Even if the Fed raises interest rates in 2022, it may take some time before deposits are affected.

While I agree with Smith that deposits may be released more quickly in this next interest rate cycle, given the size of the banking system and why they are there, some banks may have the right to release some deposits. For example, JPMorgan added more than $700 billion in deposits between the end of 2019 and the end of the first quarter of this year.

The bank has far more deposits than it can realistically use in the near future, and deposit growth has become a regulatory issue for JPMorgan, so the bank may be right to dump some of the more interest-sensitive deposits before rates were raised. Anyway, be aware of the fact that banks can hold on to their deposits and keep the cost of deposits low when interest rates rise, because they will be the banks to invest in.

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Bank of America is the advertising partner of The Ascent, a motley company. Wells Fargo is the advertising partner of Motley Company The Ascent. JP Morgan Chase is the advertising partner of Motley Company The Ascent. Bram Berkowitz has no position in any of the aforementioned shares. Motley has no position in any of the shares mentioned. Motley has a disclosure policy.

5 companies to buy now that high interest rates may be here to stay despite a tough year. JPMorgan is holding up surprisingly well. Why JPMorgan Chase Shares Rise on Wall Street Updates Good news: JPMorgan Chase recently raised its 2022 earnings guidance. at JPMorgan Chase is clean as a whistle. So why is Jamie Dimon worried?

Calculated from the average performance of all stock recommendations since the start of the stock advisory service in February 2002. Returned on 11/04/2022.

Calculated according to time-weighted returns since 2002. Volatility profiles based on three-year trailing calculations of the standard deviation of the return on service investments.

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