Banks Short – or Long – on Deposits Can Go to the Markets
Innovative private-sector platforms can help navigate rough patches, but they’re not designed to rescue banks on the brink
Friday, May 12, 2023
By John Hintze
The basic business of a bank is to take deposits and make loans, an intermediary function governed by asset and liability management (ALM). The depositor runs that brought down Silicon Valley Bank (SVB) and Signature Bank in March, and First Republic Bank several weeks later, did not only demonstrate – in the extreme – what can go wrong when liabilities are not sufficiently funded and liquid. They also brought new attention to existing mechanisms for adjusting deposit levels.
Among these are so-called deposit networks, which banks have found useful not just during the most recent turmoil, but throughout the period of rising interest rates and variable flows of funds.
“We’re seeing increased usage of every sort of funding product available in the market, whether it’s deposits or wholesale funding in nature,” said Todd Cuppia, managing director and head of the Balance Sheet Risk Management practice at Chatham Financial. “Banks are going to every outlet they have, especially to [deposit networks] where there’s actual deposit insurance that benefits clients.”
In the case of two such entities, IntraFi Network and Reich & Tang Deposit Solutions/Total Bank Solutions (R&T/TBS), a bank can arrange insurance coverage for deposits exceeding the FDIC’s $250,000-per-account limit by distributing the funds among other network members. That serves as a customer-relationship benefit while enabling the bank to optimize deposit levels relative to assets and other liabilities.
Economist Alan S. Blinder is a co-founder of IntraFi Network.
Such facilities could have helped the recently defunct banks lessen their heavy dependence on uninsured deposits – around 90% at both SVB and Signature.
Publicly traded U.S. banks posted a median 0.1% increase in deposits during the first quarter, “a sign that many institutions navigated the environment relatively well,” according to an S&P Global Market Intelligence analysis. But dozens of them saw quarter-over-quarter declines exceeding 5%, with First Republic Bank’s 40.8% drop being by far the most severe.
A Federal Reserve Bank of New York Liberty Street Economics blog on May 11 noted “a considerable decline in deposit funding since the start of the current monetary policy tightening cycle in March 2022,” and accelerated deposit outflows in March 2023. That month, the largest banks reversed their outflow trend, while banks between $50 billion and $250 billion in assets suffered most acutely. Those under $50 billion “were relatively stable by comparison.”
It is standard practice to stress-test a bank’s asset and liability exposures by modeling a 3% instantaneous rate increase and decrease, said William Handel, general manager and chief economist at Fiserv’s Raddon division. “Few ever expected that could even happen, and in fact it nearly did” in 2022.
Handel said banks are likely to pay more attention to those models and ensure they have ready sources of liquidity, along with an effective communication strategy reaching customers and investors as well as their own staffs and boards. “They need to show why they are not at risk – assuming they are not – and to assure these groups that they can weather any storm,” he said.
Access to traditional funding sources, including Federal Home Loan Bank advances, brokered deposits and the Federal Reserve discount window, will typically provide the bulk of that assurance.
IntraFi calls itself the “largest banking network of its kind,” encompassing “50% of all banks in the U.S.,” 96% of them community banks. Princeton University economics professor and former Fed vice chairman Alan Blinder is a co-founder and former board member, as are Eugene Ludwig and Alfred Moses, former leaders of Promontory Financial Group.
R&T/TBS administers more than $220 billion. In February, it announced an increase in access to FDIC insurance in its Demand Deposit Marketplace Program to $50 million, from $30 million when Reich & Tang and TBS merged in June 2022.
Kevin Bannerton of R&T/TBS
“The landscape for deposit funding has changed dramatically over the past year, impacting both the supply and demand side of the market,” said Kevin Bannerton, R&T/TBS executive vice president and head of wealth management. “In this type of environment, banks value solutions that allow them to adjust dynamically as their needs change and cash investors seek the security of expanded FDIC insurance coverage and the opportunity to earn competitive rates on their excess cash.”
“With a modern tech stack built on a foundation of compliance and regulatory adherence, our marketplace has quickly been embraced by banks of various sizes,” ranging from $500 million to $100 billion in assets, Paolo Bertolotti, founder and CEO of ModernFi and an adjunct professor at Columbia University, said in a blog post.
ModernFi “connects banks with excess deposits to banks that need funding. By providing an outlet for excess deposits, the firm helps banks manage balance sheet size and earn potential revenue,” a press release explained. Andreessen Horowitz general partner David Haber stated, “After over a decade of being relatively staid, this market has become increasingly dynamic . . . With its tech-enabled marketplace, ModernFi is poised to be the interbank solution for those looking to monetize excess deposits and others that need access to balance sheet management on demand.”
In an April 4 note, ModernFi contrasted the uncollateralized nature of its offering with Federal Home Loan Bank advances. The latter are a “powerful” ALM tool, but the loans are secured and may require additional collateral, in turn limiting allocations to higher-performing asset classes.
Exchange Grows and Is Acquired
Another resource that does not tie up collateral is the American Financial Exchange (AFX), which launched in 2015 with six member banks. It now counts more than 240 members and 1,000 downstream correspondent banks, representing $70 billion in lending capacity, according to Richard Sandor, founder and chairman emeritus.
AFX founder Richard L. Sandor
AFX provides price discovery for the Ameribor benchmark rate which was developed as a replacement for Libor, with particular appeal for midsize and regional banks. Unlike the Secured Overnight Financing Rate (SOFR), Ameribor incorporates credit risk and in Sandor’s view more accurately reflects banks’ funding costs.
AFX’s average daily volume increased from inception until COVID hit in March 2020. It dropped as federal government spending lifted bank deposits, and increased again after the Fed began raising rates. Volume slumped this March following the collapse of SVB and Signature Bank, which were both AFX members. In a March 14 statement, AFX said the exchange “performed flawlessly” during the turbulence and no other banks had exposure or defaults from the closed banks.
“Equally important, the exchange’s volume for Friday, March 10 ($1.09 billion) was higher than average with no increase in volatility,” the statement said.
Transactions over AFX on that day of SVB’s closing traded in the upper quartile of federal funds, trading continued each day through the crisis, and volume has since increased, Sandor said, adding, “We tend to trade at the top end of that range, which we believe reflects the marginal cost of funds to U.S. banks.”
AFX announced April 18 that it was acquired by fintech investment firm 7RIDGE, which was founded by former Deutsche Börse chief executive Carsten Kengeter and has a portfolio that includes the multi-asset-class Trading Technologies platform.
The transaction “positions AFX with the resources and commitment to take the exchange and Ameribor to the next level, and to expand on the important work of our members in building a transparent and transaction-based benchmark and further build shareholder value,” Sandor said.
John Shay, a financial markets veteran who spent 25 years with ICAP and has served as senior adviser to the CEO of Virtu Financial, chairman of Acadia (formerly AcadiaSoft) and managing partner of Capital Market Services Inc., among other positions, was named CEO of AFX on May 2.