Thorough liquidity stress testing and conservative deposit duration assumptions have become critical after a string of bank failures showed how quickly rapid deposit outflows can overwhelm a bank.
In March, Silicon Valley Bank became the biggest bank to fail since the global financial crisis of 2007–2009, following rapid deposit outflows. That failure and the subsequent failures of Signature Bank and First Republic Bank showcased how fast and easily deposits can move in the age of digital banking, leading to much faster runs.
Now, some banks are refining their liquidity stress tests and tweaking their deposit duration assumptions to ensure their modeling is conservative and properly accounts for the rate environment, regional bank executives said at an industry conference last week.
Liquidity stress testing
"Given the environment we all just went through over the last three months or so, ... you have to reflect in an environment like this to make sure you're getting it right," Wells Fargo & Co. CFO Michael Santomassimo said about liquidity stress testing. "The big difference between what we saw [in 2008] and what we saw now is the velocity of deposit outflows that some of the banks saw in March. And so you have to reflect on that and say, 'Okay, should I tweak things or turn the dial a little bit here or there?'"
When modeling, banks should look at the granularity of their deposits by sector, type and business, Santomassimo said at a June 13 industry conference.
First Horizon Corp. is one bank that has added new stress test scenarios after the recent failures. The company is now evaluating what 24- and 48-hour deposit outflow scenarios would look like after the failures demonstrated "the amount of money that can leave your bank very quickly," CFO Hope Dmuchowski said.
"Really, what happened to First Republic and Silicon Valley, I think, has us all rethinking how we think about those funds," Dmuchowski said at a June 14 industry conference. "Every bank out there is constantly thinking about what could a one- or two-day run look like."
Conservatively approaching assumptions
Refining deposit duration assumptions is also important in an environment where high interest rates have intensified deposit competition and remaining pandemic surge deposits are liable to flow out quickly.
Though M&T Bank Corp.'s current deposit duration assumptions are "conservative," "we will continue to shorten up," CFO Daryl Bible said at the June 14 industry conference.
When modeling deposit duration, it is vital to study customers' behavior before assigning value, M&T Bank Senior Executive Vice President Darren King added.
"Someone might sell a business and you'll see a big pop-up in their deposit account. We don't give them immediate credit for that, right? We need to see what happens over time with the operational balances," King said.
Particularly when there are big upticks in deposit inflows, such as during the pandemic, it is important to approach those conservatively, according to King.
"If it came in overnight, it can go out overnight. And so we need to see some pattern before we would start to think about extending the duration of it," King said.
PNC Financial Services Group Inc. had a similar approach to the pandemic-era surge of deposits.
"The surge deposits that we received and a lot of others received, we have signed no life too. So we never viewed those as core deposits. We never managed them as core deposits. We didn't invest those core deposits," PNC CFO Robert Reilly said during the June 13 industry conference.
Basing assumptions on rates, customer type
JPMorgan Chase & Co. bases its deposit duration assumptions largely on rate levels, co-CEO of Consumer and Community Banking Jennifer Piepszak said at the June 13 industry conference.
"We're obviously less short at this higher level of rates," Piepszak said.
While the recent tumult after the failures has not prompted the bank to change its duration assumptions, it has pushed the company to look at its concentrations, Piepszak added.
"Something that we're thinking about, and I suspect many in the industry are rather than changing assumptions on duration, really thinking about given what we saw happen in March and April, the velocity of outflows," Piepszak said. "They're really looking at concentrations in the portfolio, whether it's concentrations between insured and uninsured or whether it's concentrations of affluence or geography or a certain sector."
M&T's Bible also said that diversification is key for banks' deposit bases.
Like JPMorgan, Wells Fargo also has no plans to change its deposit duration assumptions following recent events. The company's assumptions also largely change with the rate environment, with shorter assumptions for commercial deposits and longer durations for consumer deposits, Wells Fargo's Santomassimo said.
"You need to be really thoughtful in different rate environments and how those durations change," Santomassimo said. "A lot of that is embedded in all of the work that we already do and have done for a long time around remodeling that stuff. But I don't anticipate wild swings in terms of perspectives on that."
