Banks’ Funding Questions Aren’t Going Away


Even banks need to go to the bank sometimes.

With the Federal Reserve both raising interest rates and seeking to reduce the size of its balance sheet, there has been a lot of focus on the possibility of higher funding costs for U.S. banks. But even if clients are demanding higher rates for their deposits, banks have a number of places to turn. One is the Federal Home Loan Bank system. This nearly $1 trillion network of government-chartered cooperatives offers so-called advances, or secured loans, to commercial banks and others.

With loan growth coming fast in the second quarter, more lenders were turning to this funding source. U.S. commercial-bank deposits were down about 1% sequentially from the end of the first quarter to the end of the second quarter, according to nonseasonally adjusted Federal Reserve data. But meanwhile, FHLB advances jumped almost 40% from the first quarter to the second, according to the FHLB system’s combined financial report. The percentage of FHLB advances by commercial banks rose from a little over a third in the first quarter to nearly half.

So the recent news that regulators are planning a review of the 90-year-old system is something that, while seemingly arcane, might be relevant for bank investors. The overriding goal of the review isn’t yet outlined, and regulatory processes can take a long time to work through. Still, it is just one more reminder that bank investors need to be closely attuned to the menu of bank funding options.

And with the Federal Reserve’s quantitative tightening shifting into a higher gear, while the Fed’s overnight reverse repurchase agreement facility still hoovers up more than $2 trillion daily, the question of how much money will keep flowing to banks is becoming more acute. Deposits “feel particularly difficult to predict at a time when the Fed is ramping up its pace of quantitative tightening, which will take liquidity out of the system,” wrote analysts at Autonomous Research in a recent note.

Pressure on funding costs or availability hasn’t been too much of a headache yet, as interest rates are still fairly low overall and banks came into the situation with plentiful deposits—arguably too much at some banks. The national average annual percentage yield on a one-year certificate of deposit, for example, was around 0.65% at the end of August, still well below the 1% level seen as recently as 2019, according to Bankrate.com. The U.S. banking industry’s net interest income, which is driven by the difference between lending and deposit rates, and by how much lending banks do, was up nearly 10% from the first to second quarter, according to S&P Global Market Intelligence.

But there’s been enough concern among investors about the pace of this earnings growth in 2023 and beyond to hold bank stocks back somewhat, along with concerns about capital requirements and credit risk. S&P 500 banks are down 21% so far this year, more than the broader S&P 500’s 17% decline.

Add to this the general uncertainty about the economy, plus new priorities being laid out by the Fed’s new head of bank supervision, and bank stocks might stay stuck in a holding pattern for a while.

Write to Telis Demos at telis.demos@wsj.com

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