Small and regional banks in the US are troubled. Some of them have failed. The US banks’ troubles are twofold: Their asset valuations are down as the Fed raised rates by 5% in the last 15 months; and their liabilities have increased as depositors are seeking higher return and cost of debt is up.
Liabilities have gone up for two reasons: Depositors are concerned about dwindling equity of these troubled banks (tied with credit risk); and they are availing higher returns via money market funds etc.
But we are not seeing big issues in Europe – so far. Is it because European banks are managing their credit risk better and/or the possibility of availing higher returns are not that easy in Europe?
Broadly speaking several key differences with the US banking sector is an advantage for European lenders. These include tighter regulation of smaller banks, fewer choices for customers about where to put spare cash, and slower deposit growth during the COVID pandemic, which means a smaller contraction now.
According to Bloomberg, total US deposits jumped 36% from pre-COVID levels to a peak of more than $18 trillion last year. They have since shrunk 5%. In the eurozone, total deposits only grew by 24% from early 2020 to a peak of €14 trillion this year and have since declined only 2%.
European depositors also have less choice about where to keep their cash: Money market funds are less developed than in the US, while the lack of a true single banking market in Europe makes it harder for customers in one country to use a bank from another country.
Having said that banks’ lending margins will still get squeezed by customers putting more money into higher-interest savings accounts or term deposits, which is happening.
Across the eurozone, households have pulled €56.9 billion from overnight deposit accounts and added €46.5 billion to accounts with terms of up to two years, according to Pictet Wealth Management.
Several key differences with the US banking sector is an advantage for European lenders– Somnath Banerjee
Bank deposits are supposed to be ‘information insensitive’. Most people keep their money at a bank because it is convenient, it’s where their salaries are deposited, and standing orders are set up, and it would be a pain to move everything. Banks invest in customer
relationships – by building branches and cross-selling services and offering conveniences like online banking – and those relationships are long-term and sticky. In a real economic sense, banks are making loans and buying bonds that match the duration of their long-term, relationship-driven deposits.
At a very broad level I think there are two ways to think about the basic business of banking:
Banks borrow short to lend long: They use deposits to fund loans and buy bonds – Fractional Reserve Banking Model (FRBM). Here banking is an inherently risky business model (if all depositors ask for their money back at once, banks are in trouble). Specifically, it is a model with massive interest-rate risk.
Banks really borrow long to lend long: They use deposits to fund loans and buy bonds, and as a technical legal matter those deposits are short-term (and can be withdrawn at any time), but they really aren’t – It’s not really conventional Narrow Banking Model (NBM) but some people may argue it’s a variation of that. This ties in with ‘information insensitive’ depositor. Here banking is not only less risky (low interest-rate risk) but also it goes the other way.
NBM is a sort of sociologically accurate description of how banking has actually worked in practice, most of the time, for the last few hundred years. Banks do not expect all their depositors to withdraw money on a moment’s notice, because they usually don’t.
Of course, it’s not binary; actual bankers seem to have some blend of FRBM and NBM. But what they do care about is a thing called ‘deposit beta’, which means that when short-term interest rates go up by 1%, bank deposit rates go up by some fraction (the beta) of 1%: Bank depositors are slow to react to changing interest rates, for the reasons – relationships, convenience, rational ignorance.
Deposit beta in the US is higher than in Europe because European depositors seems to be more information-insensitive, at least for now.
So long as depositors feel their deposits are safe they will stay ‘information insensitive’ but the moment that’s challenged they will become ‘information sensitive’. It doesn’t take much to go through that transition.
In Silicon Valley Bank (SVB) 93% of the deposits were uninsured (higher than $250k). So, it was their instinctive reaction to withdraw/move money to another bank at the slightest hint of trouble with the lender.
Could it be that European uninsured deposits (more than €100,000) are low as percentage of total deposits, and that is the reason behind calmness? I wouldn’t know, as despite my best efforts, couldn’t find any data about it, that is in the public domain.
In essence, ‘information insensitive’ European depositors dominate currently but investors should keep in mind that it doesn’t take long for the same depositor to journey into becoming ‘information sensitive’.
Only if/when that happens the true strength of European banks will be tested.
Somnath Banerjee is head of Investment Management at Curmi and Partners Ltd.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.
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