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Surge Deposits: How to Manage the Balance Sheet in a COVID-19 World

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More than $2 trillion of deposits have flowed into U.S. banks since early March, representing an unprecedented surge. Spurred by government programs and a strong desire for liquidity by companies and consumers alike, banks are now awash in deposits. The trend is drawing attention from regulators and bankers, creating new questions about balance sheet management as old Treasury models essentially become obsolete.

Banks need to develop strategies for managing the balance sheet under myriad scenarios that could develop in coming months and years. At the heart of this strategy is the need for banks to understand the potential behavior of these surge deposits, dictating how they could be put to use on the asset side.

This should involve developing detailed surge-deposit analytics to project structural and stressed liquidity, as well as customer-level analytics to make informed estimates of balance behavior based on a vast array of data points about the customer’s past holdings, current position and likely future path.

A prudent approach can help maintain balance sheet stability through the cycle. This involves determining financial objectives and constraints, planning for multiple potential scenarios, developing a coordinated and centralized action plan and developing appropriate monitoring and governance to make course corrections as necessary.

Taking these steps now can help prevent the need for a panicked and likely expensive overcorrection down the line.

A Long List of Unknowns

The months of uncertainty around COVID-19 are unlikely to retreat anytime soon. Before the virus hit earlier this year, the banking industry had been experiencing a relatively stable deposit environment. The Fed had signaled it planned to keep rates flat for the foreseeable future, and while the deposit market was still active with accelerated money in motion, trends had become somewhat predictable. (See Figure 1.)

But the industry has been anything but stable since early March when a large influx of liquidity started to enter the system. The Fed cut rates by 150 basis points to zero in a matter of two weeks and companies planned for the worst by drawing down credit lines to shore up liquidity. These actions, combined with government programs such as the Payment Protection Program and stimulus payments, have fueled the surge in deposits. (See Figure 2.)

Figure 1: Total U.S. Domestic Deposits – Q4 2019

Figure 2: U.S. Deposit Base

Deposits by Segment (% of Total Deposits)

Source: Novantas Analysis, FDIC SOD report; Z1; Includes commercial and savings banks, savings / lending associations, and credit unions

Total U.S. Domestic Deposits

Baseline Deposits

Source: Novantas Analysis; H8 Report
Note: Total H8 deposits grossed up to equal total US domestic deposits, which includes deposits from commercial and savings banks, savings & loan associations and shares from credit unions

Figure 1: Total U.S. Domestic Deposits – Q4 2019

Deposits by Segment (% of Total Deposits)

Consumer | $6.9 T
Commercial | $3.6 T
Wealth | $2.5 T
Small Business | $1.2 T
Public Funds | $1.0 T

Source: Novantas Analysis, FDIC SOD report; Z1; Includes commercial and savings banks, savings / lending associations, and credit unions

Figure 2: U.S. Deposit Base

Total U.S. Domestic Deposits

Baseline Deposits

Source: Novantas analysis of Federal Reserve H8 Data, CARES Act, and PPP Enhancement Act

Furthermore, the ongoing pandemic has significantly, and perhaps permanently, changed the way in which people and businesses conduct themselves in seemingly every facet of life – a development that has turned past assumptions about deposit behavior on its head.

The future behavior of these deposits is now at the heart of critical questions banks are asking themselves. How quickly will these surge deposits burn down? What is the worst-case scenario? How can a bank make the distinction between high- and low-quality deposits, given there are limited differences in product and cost between them in an ultra-low rate environment?

Sensitivity to rates will also be a major factor. How will these deposits react when rates finally rise again? If rates go negative, what actions should the bank take with respect to product design, pricing and marketing? Is it wise to be the first mover or is it better to wait for others to act? How will deposit customers respond?

Finally, banks will need to consider changes to models underlying asset/liability management, funds transfer pricing and stressed liquidity, as well as the overall impact on the institution’s asset strategy.

Because they don’t know how these surge deposits will behave, most bankers have invested these funds in short-term, low-yielding assets. While longer-term assets provide limited incremental value at the moment, yield curves could steepen as the economy stabilizes. That means banks could leave valuable net interest margin on the table if they don’t optimize their balance sheets. The impact could be significant: Novantas has found that balance sheet optimization can be worth as much as 50 bp in return on equity or two percentage points of earnings per share growth – all while staying within the bank’s risk appetite.

How Banks Have Been Reacting

Banks are already pursuing different strategies to manage these surge deposits. Some bankers are happy to have them because they provide much-needed liquidity relief. Others are worried these surge deposits will crimp NIM as loan growth slows and there isn’t a productive place to put these excess deposits to use. Some are even worried these deposits will affect capital and liquidity ratios, believing they may be forced to raise capital at an expensive time. This is driving some banks to move deposits off balance sheet and/or make more aggressive rate cuts to reduce balances.

Additionally, banks are beginning to question the near-term value of low-cost core deposits if rates stay low for an extended period. Others are willing to invest in the key capabilities required to win core customers, betting the deposits and associated fees will put them in a better position if and when the economy returns to some sort of normal state and rates begin to rise.

Keeping a relatively stable balance sheet position that optimizes through the cycle is ideal.

Whatever strategy a bank is taking, the last thing a bank should do is take drastic actions only to overcorrect down the line. Keeping a relatively stable balance sheet position that optimizes through the cycle is ideal. Uncertainty in the future has only made this task more challenging: without a clear sense of what will happen in the future, it is hard to project how the balance sheet will react and what actions are needed to optimize.

The key to success is around preparing for multiple potential scenarios and being nimble enough to pivot as needed.

Strategies to Manage the Balance Sheet

Novantas believes that banks can best manage these uncertain times by first identifying their financial objectives. What is the bank looking to optimize? It may be earnings growth, return on equity and/or some other goal and it likely involves optimizing in the near-term while not sacrificing long-term success. The bank must do this while continuing to operate within its risk appetite, with a particular focus on capital, leverage, liquidity and interest-rate risk.

Once the goal is identified, the bank needs to prepare for a number of potential scenarios. Novantas recommends that these scenarios include a V- and/or U-shaped recovery, a prolonged low-rate environment – such as 0% for the next three years – and a period of negative rates.

Each scenario should include projections of funding needs (based on expected loan growth and credit performance) and how deposits will behave. This should include estimates of burndown rates and analysis of betas by deposit type when the rate cycle turns. Banks will need to reevaluate their Treasury models and apply new assumptions and overlays to account for the recent surge in deposits.

Next, banks should evaluate marginal initiatives to affect the balance sheet. These initiatives should be evaluated centrally so that they can be compared across lines of business and relative to Treasury actions. This will help the bank determine things like the need and capacity for incremental funding and which funding sources (customer or non-customer) are most efficient.

Of course, things rarely go as planned, so banks must be prepared to pivot as necessary. Banks should monitor performance and the economic environment closely, developing early warning indicators that suggest when changes are needed. Additionally, the bank should install an appropriate governance structure to ensure it is in a position to make course corrections as necessary. This will limit any “whiplash” a bank may incur as it tries to manage its balance sheet through a tumultuous environment.

The uncertainty gripping the industry today requires that banks take a thoughtful approach and prepare for a range of scenarios to manage the current surge in liquidity. Proper preparation can ensure banks aren’t left in a sub-optimal balance sheet position for whatever lies ahead.

Advanced institutions already are analyzing deposit behavior at the customer level for both retail and commercial lines of business, enabling banks to be more surgical about pricing and targeting decisions. For example, which products and customers would have the lowest balance impact from reducing rates?

In other words, the more granular, the better.


Mike Jiwani

Director – Finance & Corporate Development


Pete Gilchrist

EVP & Commercial Banking & Balance Sheet Management Sector Leader


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