Prepare for Change

By Colvin, Bob | Independent Banker, May 1998 | Go to article overview

Prepare for Change


Colvin, Bob, Independent Banker


Funding the balance sheet-what's ahead for community bankers

Editor's Note: Today's fierce competition for deposits is expected only to escalate, creating new challenges for community bankers to attract loanable funds. This is the first of a two-part series by Bob Colvin, director of community banking for Sheshunoff Business Information Group, that explains the nature of the funding challenge ahead and how community bankers can adjust for it.

significant change is taking place today that threatens to fundamentally alter the way in which bankers conduct business. As Americans move away from traditional bank products, such as savings accounts and CDs, to higher yielding money market accounts and mutual funds, several important questions arise:

What does this change in savings and investments mean over the long term for your bank? What alternatives do you have to fund your balance sheet?

How will you continue to fund the growth you are experiencing on the asset side of the balance sheet if traditional sources of deposits are not sufficient?

What management changes will be necessary for you to deal with this new environment?

What impact will these changes have on your bank's earnings? First, let's look at the current trends. If we look back 10 years at equity funds, bond funds, money market funds and bank deposits (defined as deposits in banks, S&Ls, savings banks and credit unions) and compare those numbers with today's deposits we find the following statistical trends shown in Table I on page 54.

In 1987 bank deposits represented 81 percent of the total balances in these investment categories. In just 10 years, bank deposits have declined to 51 percent of the total balances. Of America's roughly 100 million households, an estimated 37.4 percent owned mutual funds in 1997.

Looking forward, persons 50 years of age and older today will leave approximately $10.4 trillion in assets to the next generation. As this wealth is transferred, a large portion of the money currently in bank deposits will most likely find another home. While annual growth of retail bank deposits during the past 10 years has been 3.1 percent, this growth rate has declined to 2.6 percent during the past five years.

NEW FUNDING SOURCES Banks continue to experience strong earnings which fuel capital growth, and they also continue to experience strong asset demands. The missing component is the corresponding growth in retail deposits. Increasingly during the past few years, banks have been forced to use "wholesale" sources of funds to complement their retail deposits.

During the past five years, wholesale funds have grown at an annual rate of 14.8 percent. Although wholesale deposits represent only 3.2 percent of the total balance sheet today, we expect these balances to grow significantly during the next several years. Assuming retail deposits and capital continue to grow at their current pace, wholesale deposits could represent as much as 25 percent of the balance sheet within the next five years.

What are the alternatives? Does your bank simply restrain its growth to the same pace of retail deposit growth, while ignoring loan demand? What happens to capital if strong earnings continue? Do you let capital-to-asset levels increase and reduce return on equity? What will your shareholders say about that?

Bankers cannot restrain their growth or drive down their returns on equity because retail deposits are not growing at a pace to fund the balance sheet adequately. You must be prepared to deal with changing your balance sheet mix and learn the skills necessary to be a "liability manager."

The primary alternatives community bankers have to fund the balance sheet are to employ: Fed funds purchased; Repurchase agreements; Federal Home Loan Bank borrowings; and Brokered CDs. Of these alternatives, the one that community bankers seem to feel the most comfortable with as a longer term funding source is the Federal Home Loan Bank. …

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