Bankers are left to guess what will happen to their deposit bases as the Federal Reserve begins winding down its balance sheet.
The Fed began its long-awaited end to quantitative easing, or QE, this month, allowing up to $4 billion in mortgage-backed securities and $6 billion in Treasuries to mature and roll-off every month. The central bank plans to increase that cap every three months until reaching $20 billion a month in MBS and $30 billion in Treasuries.
Since the market first contemplated a Fed exit several years ago, there have been concerns that the end of QE could cause deposits to leave the banking system. Some early predictions have been watered down and analysts will certainly press for further details as third-quarter earnings kicks off this week. But the uncertainty caused by the planned Fed exit has made some bankers uneasy and only reinforces that deposits costs are poised to increase from historically low levels.
"As the Fed unwinds its balance sheet, it's a massive unknown as to what it's going to do at the back end of the yield curve, and we can all have theories on it... I think it's going to be a lot more volatile than people assume," PNC Financial Services Group Inc. Chairman, President and CEO William Demchak said at an investor conference in September.
The nation's largest banks by deposits, JPMorgan Chase & Co., suggested in May that the end of QE could destroy $1.5 trillion in deposits, roughly equal to the implied amount of reserves expected to decrease on the central bank's balance sheet. JPMorgan argued that QE effectively transformed nearly $2.5 trillion in securities into deposits. The Fed enticed holders of Treasuries and MBS to sell by increasing the value of those securities while reducing the value of cash, the bank said. The reversal of QE and expected increase in long-term rates, meanwhile, will increase the attractiveness of investing in securities versus holding cash and deposits.
JPMorgan executives have subsequently said the Fed's exit would not lead to a dollar-for-dollar reduction in deposits but could cause $500 billion to $1 trillion in outflows. JPMorgan CFO Marianne Lake has said the company's 10% share of the U.S. deposit market accordingly could cause it to experience $75 billion of deposit outflows over four years, but noted that the end of QE would slow growth, not stop growth.
JPMorgan has held this opinion for some time, predicting in 2014 that the end of QE could cause deposit outflows of up to $100 billion at the company in possibly just a quarter or two.
Excess reserves on the Fed balance sheet have already declined from the peak in the October 2015, falling by $394 billion. The banking industry's deposits have actually grown by $1.11 trillion during the same time frame.
Bankers and advisers acknowledge that the Fed's exit will spur change but some have cast doubt that deposits will leave the system.
"I'm not in the camp that there's going to be a huge outflow of money out of the industry," Scott Hildenbrand, chief balance sheet strategist at Sandler O'Neill, said during a recent podcast. He is more concerned that technology will allow customers to quickly shift funds from one bank to another.
John Shrewsberry, CFO at Wells Fargo & Co., said in July that he was "less confident" than some people who argue that depositors will rush out of the system as the Fed winds down long-duration assets. If that occurs, he said during the company's second-quarter earnings call that the impact on Wells Fargo would be proportionate to its deposit market share.
Most bankers seem to at least agree that deposit costs will move higher and the Fed's balance sheet shrinkage will contribute to those increases. U.S. Bancorp President and CEO Andrew Cecere noted on his company's second-quarter earnings call that he expects the competition for deposits to heat up as "excess liquidity" comes out of the market.
JPMorgan seems to be preparing for what it has called "uncharted territory," while acknowledging that the Fed has telegraphed its planned exit clearly.
The company has also reported some of the strongest deposit growth of any of the top 20 U.S. banks in the last year, and it stands to reason that other large banks would look to defend their deposits, to some degree, if liquidity pressures emerge. That level of competition does not appear to exist in the current marketplace and likely would push deposit costs, which have already begun to rise, even higher.