Banks/US Treasuries: banks still fighting money market funds for supremacy

Washington has successfully concluded its debt ceiling high-wire act. The next test is whether the US financial system can survive after the applause dies down.

The US Treasury, seeking to replenish its cash balance, may borrow nearly $1tn in the form of issuing short-dated Treasury bills in the next few months. How easily that flood of debt can be absorbed depends on how high coupons must climb to attract buyers. Those seeking higher risk-free returns, among them bank depositors, suddenly have more options.

Depositors have this year received lots of attention. Earlier in 2023 they pulled cash from financial institutions such as Silicon Valley Bank, fearing failures. Later they opted for higher returns, usually by shifting their funds into money market accounts.

Data from the Federal Reserve shows that while deposit flight has largely stopped, the cash in US banks, currently $17tn, is still below the figure at the beginning of the year. 

The worry in particular for smaller banks is that the government could offer yields approaching 6 per cent as the Fed’s overnight “reverse repo” deposit facility pays interest already above 5 per cent. This would put pressure on banks to raise their own deposit rates. The Treasury market has generally become far more complex and volatile. Regulation of bank balance sheets has made trading more difficult. Rising interest rates adds to this problem.

According to recent data from the Federal Deposit Insurance Corporation, aggregate US bank net income in the first quarter jumped 17 per cent, to $80bn, relative to the previous three months. It was up a third compared to a year ago. A net interest margin of 3.31 per cent — the spread between bank funding costs and interest paid to banks — fell slightly from the previous quarter.

Note that among the 4,200 smaller so-called community banks, this NIM has fallen far more sharply. Smaller institutions remain worryingly vulnerable to deposit flight. This suggests the curtain has not yet dropped on Washington’s balancing act.