Recent Trends in Deposit and Loan Growth: Implications for Small and Large Banks
Genay, Hesna, Chicago Fed Letter
Recent trends in deposit and loan growth: Implications for small and large banks
Bank deposit growth is declining. At the end of June 2000, deposits funded only two-thirds of bank assets, compared with 77% at the end of 1992. Core deposits (total deposits less time deposits larger than $100,000), the banks' bread-and-butter source of funding, have declined at an even faster rate, from 62% of total bank assets in 1992 to 46% at the end of June 2000. Not only are banks losing a stable source of funding, but the composition of deposits and other liabilities is shifting toward more interest-sensitive instruments. Banks are relying more on deposits purchased through brokers, advances from the Federal Home Loan Bank System, and volatile liabilities.
These developments are raising concerns among regulators and bankers.2 Core deposits provide a stable source of funding to banks, insulating them from fluctuations in market rates.
As a smaller portion of bank assets is funded by core deposits, banks face increasing pressure on profits. At the same time, the maturities of bank assets are lengthening, increasing banks' exposure to interest rate risk. In an environment of rising interest rates and declining asset quality, the additional pressure on profits, liquidity, and risk can affect the safety and soundness of the industry.
The negative effects of declining deposit growth can stretch beyond the banking sector. As banks' liquidity risk increases, their ability, or willingness, to fund loan growth might decrease. As a result, at a time when banks are becoming more sensitive to credit risk and tightening underwriting standards and loan terms, deposit erosion can further impair the ability of some borrowers to obtain funds or can increase their cost of funding. Because some borrowers have few alternatives to bank financing, constraints on banks' ability to fund profitable investments can adversely affect economic activity.
In this Chicago Fed Letter, I address the following questions related to changes in bank funding sources. How pervasive is the decline in deposit growth? Are all banks facing similar funding pressures? Has the erosion in deposits been greater for smaller institutions? What is the impact of declining deposits on loan growth? Is lending by small banks, which are more dependent on deposits, more likely to be constrained as a result of the decline in deposit growth? Are all loan portfolios affected to the same degree by slower deposit growth? And, what are the implications for borrowers?
Shifts in banks' funding sources
Technological advances and deregulation over the past 15 years have significantly increased the competitive pressures facing banks. Consumers and businesses that previously purchased financial services from banks are increasingly turning to capital markets or other financial intermediaries. For instance, according to Morningstar, Inc., at the beginning of 1985, there were only about 700 mutual funds, compared with over 5,500 today. Over the same period, assets of mutual fund companies increased more than tenfold in inflation-adjusted terms, to reach over $6 trillion at the end of June 2000. Rising equity values over this period undoubtedly played a large role in changing the composition of household portfolios. At the end of June 2000, deposits accounted for only 12% of household assets, down from 22% in 1990. In contrast, over the same period, equity securities and mutual fund assets held by households increased from 60% of total financial assets to, nearly 74%.
Mirroring these developments, the share of bank assets funded by deposits, particularly core deposits, has been declining steadily since 1992 (figure 1). Banks have filled the funding gap by increasing their reliance on other liabilities. For instance, at the end of June 2000, advances from the Federal Home Loan Bank (FHLB) System funded 3.0% of all bank assets, compared with 0. …