Recent regulatory changes to the liquidity coverage ratio (LCR), a post-global financial crisis reform designed to ensure bank resilience, are altering the deposit landscape across North America.
New rules in the U.S. and Canada are poised to impact deposit value. They come at a time when banks are already seeing higher deposit betas due to the recent rise in rates and increased competition for funding sources that are structurally stable, and stable in times of stress.
While regulators in the two countries appear headed in opposite directions, there is common ground in how bankers can best plan for the new environment: invest in understanding the economic-stressed liquidity of deposits at a customer level and use that information to gather, price and manage deposits more analytically.
THE LCR EVOLUTION IN THE U.S. AND CANADA
In its recent deregulation wave, the U.S. has relaxed LCR standards for banks with less than $250B in assets. As a result, LCR-prescribed runoff assumptions, which once dictated the proportion of deposit balances to be held in high-quality liquid assets (HQLAs), no longer represent binding constraints for the vast majority of banks (Figure 1). In the absence of such constraints, internally-derived economic liquidity stress testing will drive liquidity management.
While the U.S. story is one of deregulation, regulators in Canada are instead taking a sharper pencil to consumer deposit-runoff assumptions. Specifically, a proposal from Canada’s Office of the Superintendent of Financial Institutions (OSFI) would increase the liquidity requirement for non-relationship/non-transactional high-interest savings account (HISA) deposits by a factor of 2.5 times, a substantial bump in the proportion of balances that must be invested in HQLAs.
The OSFI proposal reflects a view that these HISA balances carry higher liquidity risk. This seems eminently reasonable given the 2017 deposit run on Home Capital Group when more than 50% of HISA balances fled in five business days after securities regulators accused the alternative mortgage lender of misleading investors.
THE BIG QUESTION: HOW STABLE ARE DEPOSITS FROM DIRECT CHANNELS?
Direct-channel deposits are an increasingly important funding source as depositors seek yield in a rising-rate environment and customer preferences shift toward digital interactions. Banks entering the direct arena and competing on rate are, intuitively, acquiring more rate-sensitive balances. Treasury departments must keep pace from an analytic perspective to support the internal valuation of deposits and calibration of the liquidity profile.
Direct deposits are less stable from a liquidity perspective. They are larger, less likely to be relationship-oriented, easier to move and more elastic. On the flip side, direct deposits will be stable as long as the bank’s rate remains competitive and there are no “headline” reputational events.
So, what is the right multiplier? Most banks have never been through a headline reputational event that started a liquidity crisis, so how can they model one? And if they can’t, how can they figure out how much risk is embedded in these direct deposits?
AN ANALYSIS OF WORST-CASE DEPOSIT OUTFLOWS
Novantas analyzed account-level data from its Comparative Deposit Analytics to non-parametrically extrapolate worst-case gross outflows at various confidence levels to better understand what happens to an institution if outflows spike and new inflows cease. This represents a more acute and accurate picture of stress than conveyed by net changes in balances.
The Novantas analysis of trends from branch and direct peer groups reveals that worst-case 30-day balance outflows from direct deposits diverge significantly from those of branch deposits with increasing confidence levels. In other words, the distribution for direct deposit outflows is fatter-tailed than that of branch deposits by a factor of five times at the 99.5% confidence level. (Figure 2).
The 99.5% worst-case outflows gleaned from CDA for branch deposits align with the 3% LCR-prescribed runoff rate for retail stable balances while worst-case outflows for online deposits is 15%. That far exceeds the 10% runoff rate set for less-stable retail deposits at higher confidence levels.
For banks aligning to a 99.5% confidence interval, this implies that a bank with direct deposits should be holding more liquidity — not just to meet current LCR demands, but for economic reasons.
TAKEAWAYS FOR TREASURY AND PRICING LEADERS
Banks in both countries need economic liquidity stress testing that uses customer-level analytics. While regulatory rules will present binding constraints for some, all will benefit from granularity in economic liquidity analytics. Once measured, treasury departments must determine how to allocate the cost of holding contingent liquidity for deposit runoff in a way the encourages the right deposit targeting, pricing and management.
At the same time, banks should review pricing strategies in all regimes. For those facing tighter binding constraints — either regulatory-imposed or behaviorally-derived — term products may become an attractive substitute to liquid high-rate vehicles. For banks not directly impacted, the question is whether liquid pricing strategies become more attractive, given that some competitors may retreat as their own economics change.
EVP, New York
Director, New York