By John Hintze
A year and a half after the banking stress of March 2023, regulators have started inquiring about banks’ funding mix and how it can be diversified, especially across funding sources and durations. Late last year, the banking agencies began signaling they are contemplating changes to liquidity supervision and regulation, with a focus on stress testing and discount window readiness.
Both Silicon Valley Bank and New York’s Signature Bank relied heavily on deposits concentrated among clients respectively in the technology and crypto businesses. When the now failed banks struggled to meet client demand for cash and had to sell bonds at a loss, some deposits quickly evaporated.
Those bank collapses didn’t feed into last year’s exams, when regulators were still digesting what had happened. However, that’s changing, according to Jerry Olivo, a senior adviser working with the NeuGroup’s regional bank treasurer’s group and formerly head of intraday liquidity at Citigroup.
“Several NeuGroup member banks have just gone through this year’s liquidity exams and they’re starting to see regulators imbed their thoughts from the crisis last year,” Olivo says.
The banks had already begun updating their contingency funding plans and re-evaluating what they believed to be the appropriate level of liquid assets for stressful situations.
“Based on what we’ve heard in the last few months, banks are just starting to get feedback on how regulators will be thinking about the revised stress liquidity levels banks need and how they’re sourcing it,” Olivo said.
Bank clients say regulators are generally asking them to increase the tenor of their liquidity profiles, says Todd Cuppia, head of Chatham Financial’s balance-sheet management practice. That means diversifying organic deposits to avoid relying on a concentration of customers such as tech entrepreneurs, as SVB did, and potentially expanding the use of brokered certificates of deposit. The latter provides a guaranteed source of funding over an extended duration, enabling banks better withstand volatile periods.
“In some cases, banks have doubled their exposures to those instruments since 2020,” Cuppia says, adding that while banks have struggled with the higher cost of deposits as interest rates have risen, some banks are starting to test lowering deposit rates.
For example, Fifth Third Bank’s CFO, Bryan D. Preston, noted in a June conference presentation that the bank has been able to pull back on deposit rates in certain sectors while retaining those balances. Meanwhile, S&P Global reported that several online banks, including Discover Financial Services, Ally Financial, Capital One Financial and Goldman Sachs, have lowered rates this year on their high-interest savings accounts.
“Lowering deposit costs without losing those deposits is where a bank can say it’s been successful,” Cuppia said.
The Federal Home Loan Banks have long been a significant source of liquidity for banks of all sizes. Some have called their usage into question in recent years, particularly their role as a lender of last resort. The FHLB regulator, the Federal Housing Finance Agency, in particular has expressed that the FHLBs should not be the lender of last resort and has placed emphasis on the FHLBs’ affordable housing mission over their liquidity mission, causing concern among FHLB members.
Banks have historically viewed the discount window as the funding source of last resort and have tended to avoid it. Additionally, the discount window is widely viewed as unwieldy and based on outdated technology. The banking regulators, however, have actively sought to mitigate the stigma, and the discount window does offer some advantages over the FHLBs, such as longer hours and accepting a wider variety of collateral.
“Regulators have asked banks to become more operationally ready to use the discount window and place some persistent (collateral) balances there, so in case of emergency it will be available to them without needing to move collateral,” Cuppia said.
Regulators are also considering requiring banks with $10 billion and above in assets to pre-position collateral at the discount window. To that end, banks are scouring their business lines to identify all the sources of eligible assets to use as collateral, primarily from their loan books because most of those assets are not eligible collateral at the FHLBs.
“A number of our members have mentioned reviewing their positions and finding further opportunity to place more collateral at the Fed, making more effective use of their assets on hand,” Olivo said.
There are also advantages to using the FHLBs that banks must consider when determining the funding sources to tap in stressful periods.
“The FHLBs require residential loans for collateral, and while at the Fed window it can be virtually any asset, there’s a big surcharge and it’s only for 90 days, whereas the FHLBs can lend up to five years,” says Ethan Heisler, editor of Bank Treasury Newsletter and a former bank analyst at Citigroup.
The capital markets offer another source of longer-term financing that’s been most available to the largest banks, which are currently issuing debt to take advantage of tightening spreads and dipping rates, Cuppia said. He added that it’s generally been banks with $250 billion in assets and up that have issued senior, unsecured fixed-rate notes with maturities of five years or longer. (The FHLB system is one key way that community banks access private debt markets.)
Midcap banks are also considering the capital markets, Olivo says, and recent debt and preferred stock issuance, including for M&A-related activity, is more than it has been in the recent past. While issuing longer-term debt could provide a stable source of funding during stressful period, he says, bankers are still working through how regulators and investors will respond.
“It’s not just the bank deciding whether to issue debt, but whether there will be investor interest, what capacity there is in the marketplace and for what size banks,” Olivo says. “Funding in a new environment they didn’t really face before is a challenge, as is trying to understand what the regulators and investors want. This is very much an ongoing process.”
The mix of funding is clearly going to differ for every bank. However, diversifying liabilities is clearly a priority, followed by diversifying the durations of those liabilities.
“Banks need that mix of collateralized borrowings, uncollateralized borrowings and a good mix of the maturity spectrum as well,” Cuppia said.
John Hintze frequently writes for the ABA Banking Journal.
