Deposits: Let's Talk

According to the Independent Community Bankers of America (ICBA), stablecoin wallets could suck $1.3 trillion, with a "T", out of the insured deposit system. Predominantly from banks. I'm thinking the ICBA would care less about deposits leaving credit unions.

The concern and the headline number is that if stablecoin becomes a widely adopted payment rail, like ACH, wires, and Visa/MC, and stablecoin issuers can offer rewards, then businesses and perhaps individuals will park more of their cash holdings in a stablecoin wallet. The other payments rails flow through banks, so the "wallets" are essentially the customer operating accounts.

Do I think the great vacuum sucking machine of deposits leaving banks for stablecoin wallets will come to fruition? Probably not, at least not at the levels projected. And the Clarity Act recently failed to pass the Senate, due in part to not closing the rewards loophole, more like a tunnel a freight train could pass through, left in the Genius Act that forbids the paying of interest to stablecoin providers but does not forbid rewards. 

And bankers are beginning to adapt. The Clearing House is developing a shared, bank‑led platform for clearing and settling tokenized deposits. It is designed to keep customer funds inside regulated bank accounts while adding on‑chain speed, programmability, and 24/7 settlement. A cadre of bank trade associations are doing the same in an initiative called Bank Chain. 

Even if the $1.3T is a huge miss, I think we're missing where there is titanic risk. The alternatives to bank deposits. Before I elaborate, let's look at past behaviors during different rate and pricing transparency in the recent past.

The above chart is a macro look at the spreads delivered by asset products, namely loans and investment securities, and liability products, primarily deposits, during different rate scenarios. The dotted line represents the Fed Funds Rate. The orange line, asset spreads. And the green line, liability/deposit spreads. Many of my readers know that my firm measures product profitability for community financial institutions on an outsourced basis and that is where I am getting these statistics from. Our outsourcing client averages.

In 2006, when the Fed Funds Rate was 5%-5.25%, as it was in 2023, deposit spreads actually exceeded asset spreads although deposits have negligible credit risk. At that time, there were nearly 100,000 bank branches nationwide.

Then came the Great Recession and the Fed Funds Rate fell to zero. Deposit spreads plummeted and lingered around 1% for the remainder of the zero-rate environment until the Fed started tightening in 2017. The number of bank branches plummeted to around 70,000. Why? Deposits were less profitable. Therefore branches were less profitable. And the declining number of customer visits to branches made them easy targets for consolidation. And as it turned out, there was little deposit attrition from consolidated branches. 

Because customers did most of their transactions online or on mobile. No branch. No problem. 

At peak Fed Funds Rate in 4Q07, average deposits per personal money market accounts were $55,000. After it went to zero, that number declined to its trough of $45,000 in 4Q08. Perhaps it was households burning through cash. But once rates went to zero and stayed there until 2017, personal money market average balances per account methodically climbed to $93,000. Why not keep it in an FDIC insured account with immediate availability if rates were minimal no matter the instrument of choice?

When rates shot up again in 2022, something different happened. At Covid's start in 1Q20, average balances per account was $94,000. Two years later, 1Q22, the average balance was $131,000. Zero rates. Government stimulus. Economic uncertainty.

Then inflation and the Fed's rapid response to try and curtail it in 2022 and 2023 by raising rates faster than at any time in recent memory. What happened to the average balances per personal money market accounts? They plummeted from its 1Q22 peak to a 3Q24 trough of $76,000 per account, a 42% decline. A similar thing happened in interest bearing retail checking accounts. Where did the money go?

The below chart shows that some flowed into CDs, as the proportion of CDs to total deposits shot up from around 15% to over 30% during the rates up period.

That would be the good news. Lower cost interest bearing checking and money market balances flowed to higher cost CDs. Still in our bank. But that isn't the whole story. Not by a long shot.

The above chart shows the Breckenridge ski lift rise of money market mutual fund assets, a clear alternative to bank accounts. Sofi Bank, a neo bank that has high yielding assets (mostly student loans) funded by high-cost deposits, grew from $155 million in deposits in 2022 when it acquired a small California bank to $47 billion in deposits today. Where did those deposits come from?

So my concern is less about where the stablecoin deposit headwind will take us, and more about where neo banks and alternatives to bank deposits will take us if we continue to manage our funding like we have done in the past. Because if we keep rates low during Fed tightening periods, people will seek alternatives, like they did in 2022-23. And they won't even call us to complain.

How will we change our funding strategy to mitigate this risk?

~ Jeff

Bankers: Ask What Customers Want. Then Do That.

Steve Jobs showed customers what he thought they would want, and convinced them that they wanted it. An unlikely scenario for bank products, wouldn’t you agree?

So what do your customers want?

This presumes you know who your target customers are. Bankers used to try and be everything banking to everyone in the towns where they had branches. This approach left the legacy of the General Bank. Where the answer to the question on what your bank is known for was “nothing in particular”. Or the most common bromide, “superior service”. We’re still either stuck on this legacy or are shedding it at tortoise pace.

Identifying your target customers does not mean you will not serve others. But who do you want your front line people focused on? What processes do you want to streamline first in your support functions to provide superior service? What technologies do you want implemented right away?

The answer to the above should be based on your strategy. And your strategy should be based on target customers. And target customers should provide sufficient quantity, growth, and margins to serve and meet your desired profitability. 

Next question… what do these customers want? 

Take SoFi as an example. Their desired customers are millennials with college degrees that typically result in higher paying jobs. Pretty specific. They started their company refinancing student loans, because their target audience was graduating college, and many of them with high impact degrees such as lawyers or accountants had mountains of student loans.

As their target audience ages, they are moving on to other financial needs, such as car loans and mortgages. In fact, SoFi applied for an industrial loan bank charter to offer banking services to their target customers. They later withdrew because their CEO left. But still, here is a company focused on their target customers and were building the lineup of products they demanded.

How about you? If your audience is small businesses, do you offer the lineup of products they want? Bankers frequently impose limits on their product set based on what they want to put on their balance sheet. Must this be so?

I marvel at the ROE of the New York City loan broker. Many if not most loans (other than the very large ones) in NYC are handled by loan brokers. They match borrowers and lenders. For a fee. Like 1.25% of the loan balance. So a $3 million loan deal, chump change in NYC, yields a $37,500 fee for a guy/gal that has a storefront in Astoria, Queens. 

Back to the small business. What if they want early stage funding and that type of lending doesn’t fit your bank’s risk appetite? Why can’t you broker it and match them with a partner that does? There are partnerships you can forge with non-competitors to meet this customer demand. It’s not like you haven’t done this before. How about SBA lending, or merchant services? You likely partner with someone to provide these services.

Why not identify all of the financial products and services your target customer segment demands. And figure out how to offer it.

Or, you could send them somewhere else.

How do you meet the financial needs of your target customers?

~ Jeff


Note: This is my last post of 2017. I want to let all of my readers know that I appreciate your readership and comments. Thank you! And have a safe New Year celebration and a blessed 2018!

Don't Bank. SoFi

After its most recent capital raise in September, SoFi, a marketplace lender that focuses on millennials, has raised nearly $1.5 billion in equity capital since its founding in 2011. By comparison, over 100 year old and $7.7 billion in asset Union Bank & Trust in Virginia had $1.1 billion in equity capital, with a market capitalization close to book value. 

Since 2011, SoFi has funded over $6 billion in loans (through December 15, 2015). And today, they are embarked on a campaign against banks.

Warren Buffett was right when he said "You never know who's swimming naked until the tide goes out." SoFi started in 2011, so the tide has not yet gone out on them. Like most marketplace lenders, SoFi claims a borrower risk rating system that is better than the FICO score. And in fact, is claiming a FICO score free zone. How good is their system compared to FICO, or other FinTechs that feel they are more evolved in credit risk management? We don't know. And I suspect we won't know. Until the next time the tide goes out.

Remember during the depression when the National Housing Act of 1934 created the Federal Housing Administration (FHA). Perhaps not. But during the depression, the typical mortgage was a five year balloon. So when 1/3 of borrowers lost their jobs, they were unable to re-finance when their balloon came due. Forcing them out of their homes. In came the FHA, with mortgage insurance to protect lenders, and the beginning of what is now a 30-year mortgage with a significant secondary market.

The secondary market removes unpalatable interest rate risk from financial institutions' balance sheets. Similarly, SBA guarantees reduce risk for small business lending. Reducing risk by transferring it to someone else is not new.

Marketplace lenders reduce risk for their loans similar to how financial institutions do it for mortgages and small business loans. They transfer it to investors. Many of the investors are other financial institutions! 

Sure, the originating institution retains some risk. I'm not privileged to see the contracts and know if there is recourse back to marketplace lenders for their loans. For financial institutions originating and selling residential mortgages, they retain some risk for early pre-payments or early defaults up to a certain point in time. And for fraud without a time limit. Absent those items, mortgages sold in the secondary market are at the risk of the investors.

So, too, I would suspect is the risk to SoFi and other marketplace lenders. Meaning the lion's share of SoFi swimming naked when the tide goes out is born by those that buy those loans. It is an agency problem that we saw before, in the 2007-08 mortgage crisis, when mortgage brokers and bankers, knowing they were transferring risk, pushed all sorts of loans through the system, so long as they adhered, however loosely, to the investors' underwriting criteria. What was best for the borrower was an after thought, in many cases.

Each recession is different. And certain asset classes are affected differently. In 2007-08, the first asset class impacted was residential mortgages. Banks likely felt it more in their investment portfolio as they were chock full of collateralized mortgage obligations and mortgage backed securities. Fannie Mae preferreds, anyone? 

Next recession may be different. And it will be interesting to see how the portfolios generated by these marketplace lenders perform. And who would actually own those portfolios should they tumble.

Maybe we can create another agency like the CFPB! Something to look forward to.

~ Jeff