Ever get the feeling banks favor overnight deposits over time deposits even though they shouldn’t, at least from a risk perspective? That’s the conclusion of at least one member a NeuGroup peer group who late last year said that conversations with several banks, along with tracking their rates, led him to conclude that they favored overnight deposits over time deposits – despite the greater risk attached to longer-term investments.
Although contrary to market fundamentals, at least on the surface, this appears to have been the case for decades, although perhaps it won’t be for much longer. Another peer group member, the senior manager of capital markets at a major Internet-based company, also noted that to match the overnight rate paid by a major global bank required investing in the bank’s time deposits going out at least three months.
“When time deposits mature investors actively evaluate alternatives and move deposits,” he said. “With cash, the lack of a maturity date seems to reduce movement of funds.”
In fact, that does appear to be the case, according to Anthony Carfang, managing director at Treasury Strategies, a division of Novantas, Inc. Banks view overnight deposits as longer term, he said, in part because they view it as stable money their corporate clients are storing to maintain liquidity and to pay for residual transactions. Time deposits, on the other hand, tend to be slated for a specific purpose when they mature, and so leave the bank or may have to be renegotiated. Perhaps more importantly, banks effectively have to repurchase time deposits, creating a new certificate and new borrowing terms.
In addition, the cost of time-deposit funds rise and fall with market rates. “Time deposits are far more rate sensitive, and from a bank’s perspective, being less rate sensitive is much more attractive,” Mr. Carfang said.
Paying similar rates for overnight and time deposits, however, is problematic from a risk perspective, and new regulations aim to correct that. Basel III’s liquidity coverage ratio became effective in July, and it effectively penalizes banks for excessive overnight deposits.
The Federal Reserve Bank of Richmond noted in an economic brief last year that overnight loans add reserves to a bank’s balance sheet, which although count as HQLA in the numerator of the LCR, do not help satisfy the LCR requirement because they represent a source of funding that can run off within the 30-day stress scenario modeled in the LCR denominator.
“As a result, banks facing an LCR shortfall may prefer term funding, which has maturity of greater than 30 days and satisfies both LCR and reserve requirements,” the brief says.
At the start of 2018, the net stable funding ratio goes into effect, complimenting the liquidity ratio by giving term deposits more favorable capital treatment.
“For most banks in the US, overnight deposits are free for carry a below market earnings credit rate, whereas term deposits get re-priced at maturity, so banks will still find it attractive to have overnight deposits,” Mr. Carfang said. “They will manage their balance sheets right up to the point where they meet the technical requirements of Basel III.”
Another factor impacting rates for deposits is the specific institution’s needs. The yield curve the corporate finance executive referred to was provided by a large European bank, and non-US banks may provide especially attractive rates for deposits since their regulators are requiring them to fund loans with local deposits, Mr. Carfang said. He added that US regional banks with less access to the capital markets also tend to favor deposits.