2 Jan, 2024
High funding costs will linger in 2024 as US banks jockey for deposits
By Alex Graf and Syed Muhammad Ghaznavi
US banks' deposit cost pressure subsided in the third quarter of 2023, but the industry is unlikely to see much more relief in 2024 despite the Federal Reserve's planned rate cuts.
The industry median cost of funds — calculated as total interest expense as a percentage of average interest-bearing liabilities and average non-interest-bearing deposits — was 1.62% as of Sept. 30, 2023, up 26 basis points quarter over quarter and 121 basis points year over year, according to S&P Global Market Intelligence data. That sequential increase was slower than in previous quarters this year in a sign that funding costs are beginning to stabilize.
But deposit competition will remain elevated in 2024, and cost of funds relief may not come as quickly as bankers might hope, experts said in interviews with Market Intelligence.
"It's going to be a challenging deposit market for some time. We're under no illusion. It's hard to win those deposits," OceanFirst Financial Corp. Chairman and CEO Chris Maher said in an interview. "It's a bit of a trench warfare."
Elevated deposit competition to keep funding costs higher for longer
While the Fed signaled it may lower rates in 2024, banks will not see widespread deposit cost relief in the new year because competition will remain stiff as the industry looks to replace wholesale funding with core deposits and diversify their deposit bases.
In the aftermath of the liquidity concerns following the failures in March 2023, many banks tapped wholesale funding such as brokered deposits and the Federal Home Loan Banks. Now, many institutions are
"Almost universally, the amount of investments planned for [2024] in marketing to gather deposit products will be higher than it has been in years past," said Lazzaretti, whose firm works with many of the 50 largest US banks.
Moreover, banks are looking to diversify their deposit bases more than ever before following the bank failures in 2023, which were partly due to concentrated deposit bases.
"It's important to have multiple points of liquidity," even if some of those deposits come at a higher cost, OceanFirst's Maher said.
OceanFirst reported $10.53 billion in deposits at Sept. 30, 2023, up from $10.16 billion in the linked quarter and $9.96 billion in the year-ago period, according to Market Intelligence data. But the growth came at a cost, with the company's cost of interest bearing liabilities up to 2.71% in the third quarter of 2023 from 2.39% in the second quarter of 2023 and 0.69% in the third quarter of 2022.
"What you're doing is you're building a very resilient deposit base where you do not have a concentration by geography or product or customer, and you can avoid those things that led to significant risk positions for the banks earlier this year," Maher said. "But some of that funding is going to be at market rates and some is going to be lower."
Looking for deposit cost relief
However, other banks might be keen to get deposit cost relief in the new year, even if it comes at the risk of losing deposits, President and CEO of Darling Consulting Group Matt Pieniazek said in an interview.
"We're seeing a growing number of banks starting to say, 'We're willing to risk some outflow to bring our cost down,'" Pieniazek said.
Still, banks may face pushback from customers as they work to lower depository rates and should be ready to adapt accordingly, Pieniazek said.
"You've got to be ready to change your dance," Pieniazek said. "Experiment. Go fast. Go slow. That's kind of what we're seeing out there, but there's a net bias for a concern about doing too much too quickly."
Even so, Pieniazek estimates the Fed would need to cut rates by 75 basis points or more before the industry's average cost of funds comes down.
