The high-wire act over the debt ceiling in Washington has come to a successful conclusion. However, the financial system in the United States now faces a new test. The US Treasury is expected to borrow nearly $1tn in the form of short-dated Treasury bills in the next few months to replenish its cash balance. The success of this move depends on the availability of buyers, which in turn depends on the interest rates that are being offered. Bank depositors now have more options and they may seek higher risk-free returns.
Depositors have been receiving much attention this year. Earlier in 2023, they withdrew cash from financial institutions such as Silicon Valley Bank, fearing failures. Later, they opted for higher returns by transferring their funds into money market accounts.
According to data from the Federal Reserve, while deposit flight has largely stopped, the cash in US banks is still below the figure at the beginning of the year, currently standing at $17tn.
The concern, particularly for smaller banks, is that the yield offered by the government could approach 6%, while the Fed’s overnight “reverse repo” deposit facility is already paying interest above 5%. This could result in banks increasing their deposit rates. Moreover, the Treasury market has become increasingly complex and volatile. The regulation of bank balance sheets has made trading more difficult, while rising interest rates have added to the challenge.
The net income of US banks in the first quarter, as per recent data from the Federal Deposit Insurance Corporation, jumped 17% relative to the previous three months to $80bn. It was an increase of a third in comparison to the same period a year ago. A net interest margin of 3.31%, which is the spread between bank funding costs and interest paid to banks, fell slightly from the previous quarter. However, amongst the 4,200 smaller community banks, this NIM has fallen far more sharply, leaving them vulnerable to deposit flight.
All of this suggests that the balancing act in Washington has not yet come to a close.
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