Rising rates lead banks to rethink credit and liquidity

Banks are taking steps to reexamine their relationships with depositors, borrowers

By Walt Williams

Like many banks, responsibilities for deposits at Frost Bank in San Antonio, Texas, are divvied among its different lines of business. But when Silicon Valley Bank and Signature Bank failed, showcasing the lightning speed at which bank runs can happen in the digital era, executives at Frost realized it quickly needed to up its game, according to Howard Kasanoff, Frost’s chief credit officer. Frost implemented new systems for tracking deposits and deposit movements, giving bank staff access to that information daily.

“Fortunately for our bank, we were starting from a position of strength,” Kasanoff said. “We were a pretty low loan-to-deposit ratio bank … We weren’t panicking about our liquidity situation. Nevertheless, we did recognize how important liquidity was in the eyes of customers and investors.”

The SVB and Signature failures have brought rising interest rates and liquidity risk to the forefront, both for banks and consumers. Banking regulators have also taken a renewed interest in the subject, with federal agencies issuing a joint update in July to urge financial institutions to regularly evaluate and update their contingency funding plans. The failures “are a reminder to depository institutions that depositor behavior and broader market conditions may evolve over time, and sometimes without warning,” the agencies noted.

Kasanoff discussed the effects of rising rates on credit and liquidity during the American Bankers Association’s Risk and Compliance Conference in June. Panelists described an environment in which the historically unprecedented fast rise in rates and subsequent bank failures has caused banks to rethink their relationships with both depositors and borrowers, at least for the immediate term.

Reassuring depositors

Following the bank failures, Frost Bank recognized that customers faced two dilemmas, Kasanoff says: Should they move their deposits because of a risk concern and a concentration concern? And should they move their deposits for more yield?

“Even though we were a very liquid bank, we decided we’re just going to take those two dilemmas off the table,” Kasanoff said. “We went and raised a specific product and 90-day CD rate to be about 10 basis points above Treasury. We didn’t need to do it and there was a little bit of internal debate about giving up margin and profitability, but at the end of the day, in the current environment, I think it’s okay to be giving up some margin right now to keep liquidity or grow liquidity, and also to allay the concerns of your customers.”

Frost Bank also doubled down on its communications outreach to depositors. “Here are the strengths of our bank. Here’s why your money is safe here,” Kasanoff said. “Let’s go talk to these folks. Even our executive management team was out there calling our customers proactively.”

Rethinking lending

Banks across the country largely tightened lending standards in recent months—a trend that Giulio Camerini, consulting principal at Crowe, said he has observed the following in activities across the country. “Some of the things you are seeing in a lot of community banks is, on the loan side, being very thoughtful about that next loan you make or that next renewal that you do—one great way to preserve capital is to not make that next loan.”

At the same time, community banks may have benefited from a recent uptick in activity in the debt buyers market, according to Camerini. “Some institutions are selectively choosing individual loans or portfolios of loans to sell—that market is getting active again,” he said. He adds that some institutions are also seeking to reduce their exposure the current environment by selling loan participations.

Thinking ahead

When working with borrowers, the main thing banks should be pushing for is more information, Camerini said. “Even if it’s within your loan agreements, request it just to see how things are going. Also take a hard look at those businesses that are highly sensitive to inventory … Some of them may have made decisions that might accumulate inventory that’s hard to unload at this time. Inventories are expensive to keep, so they might need a discount to reduce it.”

Also, keep an eye on commercial borrowers’ sales, he said. “There is no better way to understand how that customer will withstand an economic downturn than to look at their customers—how impacted are other customers going to be in a softening economy?”

Walt Williams is associate editor of ABA Banking Journal.