There’s no shortage of news about the failure on Friday of Silicon Valley Bank, the country’s sixteenth largest bank. Much of the press is about who’s to blame, what will happen to Silicon Valley depositors, how much the failure will affect tech companies and investors, and whether there are other banks that have similar issues. We’ll know more tomorrow.
In the meantime, I have an observation/question I have not seen widely mentioned. Why is there so much money held by companies and wealthy individuals in the form of demand deposits?
A demand deposit is typically a checking or savings account at a bank. As the name implies, you as the owner of the account can demand that the bank return the money to you at any time. In essence, you are making a one day loan to your bank. Your demand deposit is your asset, and it is your bank’s liability. Because they owe it to you.
In terms of your risk, if your demand deposit is at or under $250,000, the Federal government guarantees the safety of your demand deposit. To the extent that your demand deposit exceeds $250,000–––say it’s $500,000––– then that extra $250,000 is a loan to the bank and the safety of that “excess” $250,000 is based on the creditworthiness of the bank.
Silicon Valley Bank may be the proverbial “black swan,” representing a unique set of unfavorable circumstances that have put the money of large depositors in jeopardy. But for purposes of this post, that’s not what intrigues me. What’s curious to me is the rate of interest on demand deposits, which at many large banks is close to zero for checking accounts and relatively paltry on savings accounts.
For individuals and companies, the decision to hold a certain amount in a checking account makes perfect sense in order to handle transactions that normally occur. Neither an individual nor a company would ever want their check or other means of payment to “bounce.” So it makes sense to have a buffer to prevent an insufficiency of funds and to eliminate the need to be constantly monitoring whether there are funds available to handle predictable needs.
According to the Federal Reserve, there are about $5 trillion dollars of demand deposits in the United States. I don’t have a precise number of how much of that is represented by deposits in excess of $250,000, except to say it’s significant. To use the examples of two of the largest banks, about 70% of JP Morgan Chase’s demand deposits are in excess of $250,000, and 85% for Citibank. For Silicon Valley Bank that number was 97%.
Now some of that excess may be necessary for logistical purposes, but I suspect much of it is due to inefficiency and inertia in favor of banks and against depositors. For such a long time, almost 15 years, we’ve been used to interest rates at or around zero, so that it made no difference whether we held our cash in a checking or savings account or in a short term Treasury money market fund. Everything paid bupkes.
But now, because the Federal Reserve has rapidly raised rates to combat inflation, short term interest rates on Treasuries are around 5%. But the major banks continue to pay bupkes on checking balances and only bupkes-plus on savings. (Excessive use of “bupkes,” I know!)
What I don’t understand is why depositors are willing to lend money to banks at rates that are materially less than what they could get from lending the money to the US Government in the form of Treasury Money Market Funds. These funds pay 4.5% plus and have one day liquidity. Vanguard, for example, has a fund that pays 4.66% after fees.
Something else has changed since interest rates were close to this high. That was before the financial crisis when the seamlessness of moving money around online was not nearly as widely prevalent and accessible. Now it is.
So, will the biggest effect of the Silicon Valley Bank debacle be a wakeup call to large depositors to move their substantial excess money out of banks and into more efficient vehicles? And what will that mean for the banking system going forward?
If anyone has perspective on this, I’m eager to hear. Particularly if my logic is somehow flawed or my facts wrong.
Numbers sourced from S&P Global Intelligence by Semafor Business
I think your logic is sound and it points to another wrinkle, hugely in favor of the banks. If a depositor has an account with, say, $500,000 in it, and only $250k is insured, why isn't the bank paying a higher percentage on the money over $250k? We are not only lending the money to the bank when we deposit it, but the over $250k is money we lend at higher risk. When two people with identical incomes and assets apply for loans, but one has an inferior credit rating, that borrower will have to pay a higher interest rate due to the higher risk to the bank. Of course, if everyone moved all that money out of banks to Vanguard, for example, banks would have to pay more interest to get the use of it. This is a huge windfall for banks. We get sucked into making deposits with little or no return partly because of the safety of it and we get no more return when it is less safe. It's good to be a banker.
thanks David. Great read and very insightful & well thought out. No explanation yet on why Signature too but presumably the same issues. I'm just going withdrawing all my nickels and getting a bigger mattress.