The deposit franchise

 The basic question about this year’s US regional banking crisis is “why weren’t the banks prepared for the very predictable problems that they faced when interest rates went up,” and the basic answer is “because they thought rates going up would be good for them.”

Theory 2, bank deposits are actually long-term, because the banks have enduring relationships with their customers and their customers are unlikely to leave, or demand higher rates, as interest rates go up. And so banks can use those long-term-ish deposits to fund long-term assets, and as interest rates go up, the banks can earn higher rates, don’t have to pay higher rates, and so make more money. Rising rates are good. Theory 2 is the traditional theory of banking, and it is why many banks were not adequately prepared for rising rates.

JPMorgan is paying 1.21 per cent on average to depositors, lower than the 1.75 per cent average of its peers

The Federal Reserve, which both regulates banks and sets interest-rate policy, in a November report pointed to large unrealized losses on banks’ bondholdings due to rising rates. Things weren’t so bad, the Fed said, because “the value of banks’ deposit franchise increases and provides a buffer against these unrealized losses.”

Matt Levine Bloomberg 22 maj 2023


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