Depositors have accelerated withdrawals amid recent bank failures and sharply rising interest rates, raising concerns about the industry’s health and ability to withstand a crisis, an expert says.

Bank deposits fell by nearly $720 billion between the second and fourth quarters of 2022, leaving banks’ cash assets at their lowest levels in more than two years earlier this month. Banks have been slow to pass along better interest rates on traditional accounts to consumers, prompting a shift to money market funds, government bonds or other more lucrative investments.

A new $300 billion special lending program the government made available following the failures of Silicon Valley Bank and Signature Bank has since helped slow the outflow.

Many smaller banks seemingly dipped into the package to boost their assets as a precaution.

“The size of the support suggests banks have a big hole in their finances,” said Brad McMillan, chief investment officer for Commonwealth Financial Network, in a note. “They now must fill that hole, which will mean fewer and more expensive loans across the economy.”

The Federal Reserve’s key overnight rate has risen to 4.75 percent to 5 percent, up from virtually zero at the start of last year. That’s prompted yields to rise on longer-term Treasurys and other bonds, reducing the value of the lower-yielding Treasurys that banks held. The run on Silicon Valley Bank resulted in its inability to raise enough cash from the sale of Treasurys to pay depositors who were trying to withdraw their money.

Wall Street remains concerned about how much more the system could get squeezed in the central bank’s fight against inflation, despite Fed reassurances that the U.S. banking system is “sound and resilient.”

Falling deposits at banks could result in lower returns on loans or higher costs for lending. That could ultimately result in less lending and could feed into a recession.

“Those tighter financial conditions mean we are looking at a recession that will be sooner and deeper than looked likely even two weeks ago,” McMillan said.

Broader worries about the banking sector have also raised the issue of whether current regulations are strict enough to prevent future failures and systemic risks. Michael Barr, vice chair for supervision at the Fed, was already conducting a review of requirements for bank capital when the latest bank failures hit in early March.

Bank Failures Highlight Declining Deposits Industry-Wide

by The Associated Press time to read: 2 min