WEBVTT - Why Interest Rates on Savings Accounts Are Still So Low 0:00:10.240 --> 0:00:13.440 Hello, and welcome to another episode of the All Thoughts Podcast. 0:00:13.520 --> 0:00:16.479 I'm Tracy Alloway and I'm Joe. Wasn't all Joe? Do 0:00:16.520 --> 0:00:19.680 you know what the average interest rate paid on US 0:00:19.720 --> 0:00:22.400 bank accounts currently is? Holy? Because we just looked it 0:00:22.480 --> 0:00:24.279 up and I couldn't blow it. I actually thought you 0:00:24.320 --> 0:00:26.840 were wrong about as like I thought when you told 0:00:26.880 --> 0:00:30.479 me the number that you must be a despel point off. Yeah, 0:00:30.880 --> 0:00:34.800 it is surprising. So the average annual percentage yield er 0:00:34.840 --> 0:00:40.479 ap Y according to bank rate is point two three percent. 0:00:40.880 --> 0:00:43.880 And this at a time when, as you know, benchmark 0:00:43.920 --> 0:00:46.120 interest rates are at like four and a half four 0:00:46.200 --> 0:00:50.400 point seven five percent. I would have guessed that maybe 0:00:50.560 --> 0:00:53.080 they were like one and a half. Two percent was 0:00:53.159 --> 0:00:55.560 just still pretty low, right, So if you could get 0:00:55.600 --> 0:00:58.240 four and a half percent as a bank an overnight rate, 0:00:58.680 --> 0:01:01.840 and then it was like, okay, your saving your depositors, 0:01:01.920 --> 0:01:04.360 check your account whatever, you get a couple percent that's 0:01:04.360 --> 0:01:07.680 still spread, but they're still basically paying you nothing. I 0:01:07.840 --> 0:01:09.680 just want to like hold your cash there, which is 0:01:09.680 --> 0:01:12.839 pretty staggering. Absolutely, So this is a question that comes 0:01:12.920 --> 0:01:16.640 up a lot, and it's obviously frustrating. If you are 0:01:16.800 --> 0:01:19.959 a saver, you know, it's very everyone wants to be 0:01:20.120 --> 0:01:22.840 a rentier to some extent, right, I'll want to make 0:01:22.880 --> 0:01:26.160 money on our money exactly. That is the dream. So 0:01:26.200 --> 0:01:28.880 if the banks aren't passing through those interest rate hikes, 0:01:28.880 --> 0:01:34.720 it's naturally frustrating for retail depositors. However, it's also kind 0:01:34.720 --> 0:01:39.640 of frustrating from an economic slash macroeconomic policy perspective, because 0:01:39.760 --> 0:01:42.640 if you think about what monetary policy is supposed to do, 0:01:42.800 --> 0:01:45.960 it is supposed to work through changes in interest rates, 0:01:45.959 --> 0:01:48.720 which are supposed to ripple out from the central bank 0:01:48.840 --> 0:01:52.480 into the rest of the economy. Right intuitively, like one 0:01:52.720 --> 0:01:55.640 channel that you could imagine that rate hikes work through 0:01:55.800 --> 0:01:59.160 is oh, look suddenly I'm getting a lot more money, 0:01:59.360 --> 0:02:02.800 to say, or getting more Maybe I'll at the margin, 0:02:02.920 --> 0:02:05.400 I'll save a little more because I'm getting paid to 0:02:05.560 --> 0:02:08.960 spend a little less, create sort of decreased pressure in 0:02:09.000 --> 0:02:11.560 the economy. I don't know if anyone ever really thinks 0:02:11.639 --> 0:02:13.440 that way. It's like, oh, I'm not going to buy 0:02:13.600 --> 0:02:15.560 like this watch, or I'm not going to buy these 0:02:15.680 --> 0:02:18.200 like a concert tickets because I could get you know, 0:02:18.280 --> 0:02:21.440 three percent having left this money in the bank. Nonetheless, 0:02:21.720 --> 0:02:24.040 we have to get point two three percent. I'm definitely 0:02:24.120 --> 0:02:27.040 gonna okay, I'm definitely going to keep spending in that case. 0:02:27.200 --> 0:02:29.359 And of course there are ways to like get more 0:02:29.440 --> 0:02:31.080 yield and you could lock it up, but if you 0:02:31.160 --> 0:02:33.399 wanted to, you could go out, like buy a one 0:02:33.480 --> 0:02:36.680 year CICA of deposits. Wo's not going to do that, 0:02:36.960 --> 0:02:39.639 you know, You're not, Okay, it's so much to work. Okay, Well, 0:02:39.680 --> 0:02:42.000 this is clearly something that we need to talk about, 0:02:42.440 --> 0:02:45.919 both in the context of monetary policy and yes, broader economics. 0:02:45.960 --> 0:02:47.960 And I am very pleased to say that we really 0:02:48.000 --> 0:02:50.520 do have the perfect guest on this topic. We're going 0:02:50.560 --> 0:02:53.440 to be speaking with Joe Abote. He is a money 0:02:53.520 --> 0:02:57.040 market strategist over at Barclay's also does fixed income research. 0:02:57.120 --> 0:02:59.200 I've been a fan of his work for a very 0:02:59.240 --> 0:03:01.960 long time and happened meaning to get him on all 0:03:02.000 --> 0:03:05.040 thoughts for just as long. So I'm very pleased to 0:03:05.040 --> 0:03:08.760 have him here now to explain this discrepancy to us. Joe, 0:03:08.800 --> 0:03:16.000 welcome to the show. Thank you. Nice to hear. Yes 0:03:16.080 --> 0:03:20.920 and no. I think I think the fundamental problem with 0:03:21.639 --> 0:03:26.440 bank deposit rates is that there's so many different types 0:03:26.639 --> 0:03:30.240 of deposits, and because there's so many types of deposits, 0:03:30.240 --> 0:03:34.320 it's hard to kind of come up with one comparable 0:03:34.400 --> 0:03:37.960 interest rate across all banks and across all forms. Right, 0:03:38.000 --> 0:03:41.840 So you have deposits a time, deposits for example, CDs 0:03:41.920 --> 0:03:45.840 that you just mentioned, You've got checking account rates if 0:03:45.840 --> 0:03:48.920 they pay interest at all, and then you've got you know, 0:03:49.080 --> 0:03:52.600 different balance requirements for different types of customers and things 0:03:52.640 --> 0:03:56.240 like that. So coming up with an explicit, one size 0:03:56.320 --> 0:04:02.560 fits all bank deposit rate is difficult. But the phenomena 0:04:02.640 --> 0:04:06.680 that you're describing where bank deposit rates in a rising 0:04:06.760 --> 0:04:10.640 rate environment go up like a feather, and in a 0:04:10.680 --> 0:04:13.880 interest rate cutting environment where the Fed is easing policy, 0:04:14.200 --> 0:04:19.039 they sink like a stone. That's been a phenomena for decades. Well, 0:04:19.120 --> 0:04:21.719 let's get into that then. So you know the FED 0:04:21.800 --> 0:04:26.560 hikes rates on a Wednesday. Why doesn't that just automatically 0:04:26.600 --> 0:04:29.919 translate to a bunch of banks emailing savers and saying 0:04:29.960 --> 0:04:32.320 your deposit rate is going up? And I know there 0:04:32.360 --> 0:04:36.360 are a couple that do seem to automatically raise saving rates, 0:04:36.360 --> 0:04:41.360 but it's not the norm. Well, the question boils down 0:04:41.440 --> 0:04:44.520 to kind of what does the bank need right in 0:04:44.640 --> 0:04:48.119 terms of financing? Right, So most of its funding comes 0:04:48.160 --> 0:04:53.800 from deposits, and banks have a fair amount of pricing 0:04:53.839 --> 0:04:56.920 power when it comes to deposits, right, there's not many 0:04:56.960 --> 0:05:01.680 substitutes for bank deposits out You might try a money 0:05:01.760 --> 0:05:06.760 market fund, for example, or you might try, you know, 0:05:07.120 --> 0:05:09.440 bills or like some of the things that you were 0:05:09.480 --> 0:05:11.240 talking about, but you're not going to get the same 0:05:11.320 --> 0:05:16.159 level of liquidity, for example, with deposit insurance that you 0:05:16.240 --> 0:05:20.320 might with a bank deposit. And so if you're not 0:05:20.440 --> 0:05:23.839 faced with a lot of competition, and I'm talking about 0:05:24.400 --> 0:05:28.920 industry wide, then deposit rates don't necessarily have to go 0:05:29.040 --> 0:05:32.279 up lockstep with the increase in the fent funds rate. 0:05:32.680 --> 0:05:36.400 So to your point, you know, it's not terribly surprising 0:05:36.520 --> 0:05:40.920 that deposit rates don't go up immediately when the FED 0:05:41.080 --> 0:05:45.960 raises rates. Now, I will say that they do go up, 0:05:46.480 --> 0:05:51.479 and the real issue is not so much the level 0:05:51.520 --> 0:05:55.040 of rates, but the speed with which they go up, right, 0:05:55.720 --> 0:05:58.560 And that becomes a question of what people call the 0:05:58.640 --> 0:06:03.279 deposit data, which is how much of the monetary policy 0:06:03.400 --> 0:06:05.600 rate or the change in the FED funds rate actually 0:06:05.640 --> 0:06:10.920 gets passed on to depositors. And what happens is that 0:06:11.120 --> 0:06:16.440 initially in the tightening cycle, banks are over deposited, and 0:06:16.520 --> 0:06:21.400 as those deposits migrate into higher yielding products and they 0:06:21.440 --> 0:06:25.200 lose financing, they start to compete more aggressively with each 0:06:25.240 --> 0:06:28.480 other and they start to try to poach deposits from 0:06:28.480 --> 0:06:31.560 one institution to the next. And what you see is 0:06:31.560 --> 0:06:36.320 with subsequent rate heights, the deposit data right goes up. 0:06:36.880 --> 0:06:38.919 And so what you normally find is that in the 0:06:39.000 --> 0:06:42.640 last tightening cycle, for example, the pass through effect was 0:06:42.680 --> 0:06:47.039 only about thirty five to forty of the rate heights 0:06:47.120 --> 0:06:51.159 made it into bank deposit rates over the entire cycle. 0:06:51.880 --> 0:06:54.119 But if you started at the cycle, it was down 0:06:54.200 --> 0:06:56.840 around ten percent, and by the end of the cycle 0:06:56.880 --> 0:07:00.680 it was closer to seventy five or eighty percent. And 0:07:00.760 --> 0:07:04.080 that has happened, you know, pretty much every interest rate 0:07:04.120 --> 0:07:09.200 cycle going back decades, which is start low and high, 0:07:09.240 --> 0:07:13.440 but that the overall deposit beta for the cycle is 0:07:13.480 --> 0:07:17.720 somewhere around thirty to forty of the Fed's rate ings. 0:07:17.720 --> 0:07:21.160 And again, this is a competitive dynamic, right. There's not 0:07:21.240 --> 0:07:24.320 a lot of substitutes for deposits out there, right that 0:07:24.440 --> 0:07:29.280 offer the same level of deposit insurance or protection and liquidity. 0:07:30.040 --> 0:07:33.320 Then you know, banks have a significant degree of pricing 0:07:33.360 --> 0:07:36.520 power when it comes to deposits. So Joe, just on 0:07:36.560 --> 0:07:39.720 that note, this idea that eventually deposit rates do go 0:07:39.920 --> 0:07:43.520 up as the competitive process between banks kind of kicks in. 0:07:44.160 --> 0:07:46.480 One piece of interesting research that I saw from the 0:07:46.480 --> 0:07:50.760 New York Fed is this idea that deposit betas so 0:07:50.840 --> 0:07:54.000 the relationship between you know, benchmark rates and what banks 0:07:54.000 --> 0:08:00.720 are actually paying savers that they have been trending lower 0:08:01.280 --> 0:08:05.640 in later interest rate cycles. So the beta now is 0:08:05.680 --> 0:08:08.240 lower than it was in say like the early two 0:08:08.240 --> 0:08:11.640 thousands hiking cycle. It's lower than it was and sort 0:08:11.680 --> 0:08:15.200 of the most recent hiking cycle as well. What accounts 0:08:15.280 --> 0:08:17.800 for that? You know, if I had to spect you that, 0:08:17.800 --> 0:08:20.640 I'd say that there's probably two things that may account 0:08:20.680 --> 0:08:23.040 for it. One is that Kewey has kind of changed 0:08:23.080 --> 0:08:25.480 to the dynamics so that banks, you know, at the 0:08:25.520 --> 0:08:28.880 beginning of a tightening cycle are significantly more over deposited 0:08:28.920 --> 0:08:32.120 than they were in past tightening cycles. And that might 0:08:32.160 --> 0:08:36.840 account for why deposit betas are lower, because banks have 0:08:36.880 --> 0:08:39.280 a thicker cushion of deposits, and therefore they don't have 0:08:39.320 --> 0:08:41.720 to compete as readily as they did or as quickly 0:08:41.800 --> 0:08:46.560 as they did back in earlier tightening cycles. The second thing, 0:08:46.679 --> 0:08:50.840 which I think doesn't get as much attention right is 0:08:50.840 --> 0:08:54.320 the fact that I think banks increasingly, especially the larger 0:08:54.360 --> 0:09:00.440 domestic institutions, are not competing specifically on explicit interests. And 0:09:00.480 --> 0:09:03.280 I think what happens is that banks are able to 0:09:03.360 --> 0:09:11.720 pay people, especially institutions, with services, and rather than compete 0:09:11.880 --> 0:09:17.439 on interest rate, they compete on price services. So they 0:09:17.480 --> 0:09:22.000 may offer discounts, you know, volume discounts, if you want 0:09:22.000 --> 0:09:26.280 to think about it, and that that dynamic where you've 0:09:26.320 --> 0:09:31.520 got competition occurring through you know, kind of a non 0:09:31.640 --> 0:09:36.880 price mechanism, a non interest price mechanism, may alter how 0:09:37.040 --> 0:09:40.640 datas perform a tightening cycles. So I think that's probably 0:09:40.679 --> 0:09:42.840 I think those are probably the two main reasons why 0:09:43.760 --> 0:09:47.720 deposit datas are not as high as they were in 0:09:47.840 --> 0:09:52.920 previous cycles. So could factors like the quality of an 0:09:52.960 --> 0:09:56.520 online app, the size of the network, the ease of 0:09:56.559 --> 0:10:02.800 the website, the interconnectedness of a big banks website with 0:10:02.880 --> 0:10:05.880 payment apps like zell and other things like that, Like 0:10:06.000 --> 0:10:10.080 could Lease essentially be selling points where just bank X. 0:10:10.120 --> 0:10:12.080 I won't name any specific banks because I don't know 0:10:12.120 --> 0:10:14.880 the details. Bank excess look we have this great app, 0:10:14.920 --> 0:10:17.520 we have this great integration with all these things. Are 0:10:17.520 --> 0:10:21.240 you really going to move your you know, eight thousand 0:10:21.280 --> 0:10:25.040 dollars checking account over to why for one extra bank? 0:10:25.080 --> 0:10:27.040 Why for one extra percent? It's going to be like, 0:10:27.120 --> 0:10:29.360 you know, fifteen dollars extra a year and all the 0:10:29.440 --> 0:10:33.120 has to details. Yes, I think that. I think that's 0:10:33.120 --> 0:10:36.920 exactly right. I would also say that there's a time 0:10:36.960 --> 0:10:41.720 tax involved too, right, which is kind of the corollary 0:10:41.720 --> 0:10:44.680 of this, which is that your paycheck is linked directly 0:10:44.679 --> 0:10:50.120 to your checking account and you know, migrating it to 0:10:50.280 --> 0:10:55.040 a different bank requires you know, kind of contacting HR 0:10:55.280 --> 0:10:59.640 or probably filling out online forms at your office to 0:10:59.720 --> 0:11:03.520 kind of change the direction. And that's a hassle. And 0:11:03.720 --> 0:11:08.840 I think the hassle effect is probably what keeps deposits sticky, 0:11:09.280 --> 0:11:12.160 as well as the service effect that you mentioned, right, 0:11:12.200 --> 0:11:17.360 the non non price services. I would suspect that the 0:11:17.360 --> 0:11:22.480 effect is actually bigger for institutional deposits than it is 0:11:22.520 --> 0:11:27.960 for retail depositors. Right, that institutions obviously face much bigger 0:11:28.000 --> 0:11:33.439 costs switching banks. In addition to other non price services, 0:11:33.440 --> 0:11:37.360 which might include investment banking advice or things along that nature. 0:11:37.920 --> 0:11:41.720 That make deposits a little bit more sticky at the 0:11:41.760 --> 0:11:45.280 institutional level as well as it's a retail level, so 0:11:45.320 --> 0:11:48.800 it's not just retail but also institutions. Right, if you're 0:11:48.920 --> 0:11:51.440 a treasurer for a large company, I can imagine that 0:11:51.480 --> 0:11:55.760 there's a whole process to changing your preferred bank. Right. 0:11:56.000 --> 0:11:59.320 You know, Tracy and our producer Dash, I'm not going 0:11:59.360 --> 0:12:01.760 to say which one, but they're both customers of a 0:12:01.840 --> 0:12:05.760 certain large banks fintech arm and they're also talking about 0:12:05.760 --> 0:12:08.600 always talking about like the juicy interest rates they're getting 0:12:08.600 --> 0:12:11.640 on their checking accounts. But it does seem like kind 0:12:11.679 --> 0:12:13.640 of a hosshold. So yes, it is more money, but 0:12:13.800 --> 0:12:16.520 I don't really want to deal with it. What you know, 0:12:16.520 --> 0:12:20.520 when we talk about competition, what about sort of like 0:12:20.840 --> 0:12:24.720 classical ideas about market structure in terms of the number 0:12:24.760 --> 0:12:27.280 of banks, the size of the banks, the rise of 0:12:27.280 --> 0:12:32.360 like a handful of these mega national banks, and does 0:12:32.400 --> 0:12:35.440 that play and you roll in the sort of decline 0:12:35.480 --> 0:12:38.600 and deposit betas over time. You know, I'm not an 0:12:38.679 --> 0:12:43.199 industry analyst at that level. You know, we do have 0:12:43.240 --> 0:12:45.640 a lot of banks in the US, and there is 0:12:46.080 --> 0:12:54.920 definitely a convenience factor to location. So hard to know 0:12:56.640 --> 0:13:00.080 how that plays out, at least in my mind in 0:13:00.160 --> 0:13:03.920 terms of deposit concentration. But deposits are definitely concentrated in 0:13:03.960 --> 0:13:06.240 the US at the largest banks. I will say that 0:13:07.240 --> 0:13:10.280 now again, is that because of the stickiness of those banks, 0:13:11.320 --> 0:13:16.480 or the convenience or their online services or their network effects. 0:13:16.880 --> 0:13:31.959 I suspect it's a variety of everything. So one thing 0:13:32.000 --> 0:13:34.440 I wanted to ask is, you know, the way sort 0:13:34.440 --> 0:13:37.680 of retail deposits are supposed to work is you give 0:13:37.720 --> 0:13:41.960 the bank money, they pay you some interest, and the 0:13:42.080 --> 0:13:45.800 interest is coming from I guess the array of central 0:13:45.840 --> 0:13:49.520 bank facilities nowadays, but also from the bank taking your 0:13:49.559 --> 0:13:53.360 money and lending it out into the wider economy. So 0:13:53.600 --> 0:13:57.800 to what degree our bank deposit rates also a function 0:13:57.960 --> 0:14:02.000 of the lending or investment opportunities that banks see in 0:14:02.000 --> 0:14:05.240 the market. The primary driver is going to be asset 0:14:05.240 --> 0:14:08.760 growth on the bank side, right, That determines how competitive 0:14:08.800 --> 0:14:12.200 banks have to be in deposits. And so if you 0:14:12.200 --> 0:14:14.720 think about the bank's balance sheet on the asset side, 0:14:14.720 --> 0:14:17.720 it's got essentially three types of assets. It's got loans, 0:14:18.160 --> 0:14:21.400 it's got cash that it has to maintain for regulatory purposes. 0:14:21.400 --> 0:14:24.920 At the few reserve and it's got securities holdings. Right 0:14:25.360 --> 0:14:28.760 on the liability side, most of its funding comes in 0:14:28.800 --> 0:14:32.040 the form of deposits of some kind, and there's an 0:14:32.080 --> 0:14:35.600 advantage to deposits, especially retail deposits, because as you said, 0:14:35.840 --> 0:14:38.880 they are pretty sticky, right, and the stickiness is partly 0:14:38.920 --> 0:14:41.400 a function of the services, but it's also a function 0:14:41.440 --> 0:14:47.440 of government guaranteed deposit insurance as well. In addition to that, 0:14:47.520 --> 0:14:50.400 there's wholesale funding that they can rely on. Now, whether 0:14:50.480 --> 0:14:56.920 that's commercial paper or turned financing, corporate debt, etc. These 0:14:56.920 --> 0:15:01.720 are all supplemental forms of funding that they can rely 0:15:01.920 --> 0:15:06.920 on to camp up their funding as asset growth, you know, 0:15:07.000 --> 0:15:10.560 as assets growth, and so from banks perspective, it's got 0:15:10.560 --> 0:15:13.040 to figure out and it's got to balance on the 0:15:13.080 --> 0:15:18.040 asset side the interest returns on its earning versus interest 0:15:18.080 --> 0:15:21.320 costs of raising more deposits are raising more wholesale funding, 0:15:21.600 --> 0:15:26.120 and that balancing act is really blue way Monetary policy 0:15:26.280 --> 0:15:31.120 is expected to unfold, right, Monetary policy is expected to 0:15:31.200 --> 0:15:34.840 kind of influence that dynamic. The asset side of the 0:15:34.840 --> 0:15:38.920 balance sheet determines how you decide to fund it, whether 0:15:39.000 --> 0:15:42.400 you're using deposits, which are probably the cheapest, stickiest form 0:15:42.440 --> 0:15:46.560 of funding, or whether you're using wholesale funding right, which 0:15:46.600 --> 0:15:50.400 is a little bit more expensive, more flight prone, but 0:15:50.920 --> 0:15:54.720 you know, depending on your size, may be easier to 0:15:54.880 --> 0:15:58.080 raise because you have more market access than say a 0:15:58.160 --> 0:16:02.720 smaller institution. So it becomes kind of a question of 0:16:03.040 --> 0:16:06.440 at least monetary policy becomes a question of how to 0:16:06.560 --> 0:16:12.880 banks triage between their asset growth deposit the loans securities 0:16:12.880 --> 0:16:17.280 in cash versus their liability side deposits and wholesale funding 0:16:17.360 --> 0:16:21.040 for its commercial paper, corporate bonds, other you know, kind 0:16:21.040 --> 0:16:23.880 of term financing that's available out there, and that kind 0:16:23.880 --> 0:16:27.320 of balancing is the way monetary policy is supposed to 0:16:27.360 --> 0:16:32.120 affect bank lending decisions and the transmission of the Fed's 0:16:32.200 --> 0:16:36.160 interest rate changes. Can you talk a little bit more 0:16:36.360 --> 0:16:41.840 about how retail deposits as a source of funding, their 0:16:41.960 --> 0:16:44.760 role in twenty twenty three or twenty twenty two or 0:16:44.760 --> 0:16:49.240 whatever versus the past, What is the like how would 0:16:49.280 --> 0:16:51.840 you know if we're having this conversation in the nineties 0:16:52.160 --> 0:16:55.040 or early two thousands, what is the role of retail 0:16:55.080 --> 0:16:58.320 deposits as a source of funding then versus today? Has 0:16:58.360 --> 0:17:01.440 it changed? Yeah? So what I would say is that 0:17:01.520 --> 0:17:06.600 retail deposits have actually become more important over time because 0:17:06.600 --> 0:17:09.399 of regulatory changes. So if you're called back before the 0:17:09.440 --> 0:17:14.040 financial crisis, one of the things that was happening was 0:17:14.080 --> 0:17:19.040 that banks were increasingly reliant on wholesale funding. And they 0:17:19.160 --> 0:17:21.199 went to wholesale funding because it was cheap and it 0:17:21.280 --> 0:17:26.440 was readily available. But the result of that wholesale funding 0:17:26.480 --> 0:17:29.600 reliance was that a lot of their funding became very 0:17:29.680 --> 0:17:35.199 very rate sensitive and very rate or rather very flight prone. 0:17:35.960 --> 0:17:39.600 And you can imagine an extreme situation where you're financing 0:17:39.680 --> 0:17:43.119 let's say, thirty year mortgages and you're financing them on 0:17:43.160 --> 0:17:46.080 an overnight basis in the repo market, you have a 0:17:46.160 --> 0:17:51.040 significant maturity mismatch, right where if that repo funding can't 0:17:51.040 --> 0:17:55.040 be rolled, you lose your source of financing for those mortgages. 0:17:55.680 --> 0:17:58.920 And so one of the consequences of the financial crisis 0:17:59.040 --> 0:18:02.560 when we aw that funding was as light prone as 0:18:02.600 --> 0:18:07.520 it was, particularly in these markets, regulators kind of emphasize 0:18:07.640 --> 0:18:10.920 the need for banks to a hold more liquidity, whether 0:18:10.960 --> 0:18:14.800 it's told higher cash balances at the FED right and 0:18:14.960 --> 0:18:21.120 simultaneously rely more heavily on wholesale funding on retail funding, 0:18:21.440 --> 0:18:24.600 that is deposit based funding. And so we've seen over 0:18:24.600 --> 0:18:28.080 the last really twenty years or so as a decline 0:18:28.119 --> 0:18:32.600 in the ratio of repo funding CP market funding, you know, 0:18:32.640 --> 0:18:35.640 kind of these financial instruments of short maturities and we're 0:18:35.680 --> 0:18:38.840 financing asset growth, you know, before two thousand and six, 0:18:39.359 --> 0:18:43.280 and those have been replaced by more deposit funding now. 0:18:43.440 --> 0:18:46.840 As I said earlier, initially that would be reflected in 0:18:46.960 --> 0:18:50.240 higher deposit rates. Of course, que at the time at 0:18:50.280 --> 0:18:54.720 suppress deposit rates. And if you recall that before twenty 0:18:54.880 --> 0:18:59.160 and twelve, right, we had unlimited deposit insurance on transaction 0:18:59.280 --> 0:19:02.040 fought accounts for a while, right, in order to kind 0:19:02.080 --> 0:19:07.120 of keep funding stable for banks. What's happened since then, right, 0:19:07.160 --> 0:19:09.719 as as interest rates go up, as I said earlier, 0:19:09.760 --> 0:19:12.159 banks have been able to compete on non price or 0:19:12.280 --> 0:19:15.720 non interest rate services more and the deposits have kind 0:19:15.720 --> 0:19:18.840 of remained sticky. So you have this kind of wholesale 0:19:18.880 --> 0:19:23.600 shift away from kind of wholesale funding to retail deposits. 0:19:24.000 --> 0:19:25.920 And if you want to go back even further, this 0:19:26.080 --> 0:19:29.600 looks more akin to an environment that kind of existed, 0:19:30.440 --> 0:19:33.680 you know, prior to the nineteen eighties, right, to an 0:19:33.760 --> 0:19:38.480 environment where banks were much more deposit reliant and much 0:19:38.560 --> 0:19:43.159 less relying on financial products. And if you look back, 0:19:43.520 --> 0:19:47.520 you know further, this is kind of really beckons to 0:19:47.640 --> 0:19:50.640 an era of you know, kind of pre interest rate 0:19:50.720 --> 0:19:54.960 decontrol for nineteen eighty. But again that's that's going back 0:19:55.240 --> 0:19:59.200 a lot of many, many many years now, right, So, 0:19:59.560 --> 0:20:02.800 depot sets are more important as a source of bank 0:20:02.840 --> 0:20:06.160 funding thanks to the experience of the financial crisis and 0:20:06.359 --> 0:20:11.120 post GFC regulation, and at the same time, because we've 0:20:11.160 --> 0:20:15.280 had things like que a lot of banks are simply 0:20:15.400 --> 0:20:19.280 swimming in deposits to the extent that they kind of 0:20:19.359 --> 0:20:23.000 have more than they perhaps need, which means that they 0:20:23.000 --> 0:20:28.040 are willing to allow depositors to maybe look elsewhere for 0:20:28.119 --> 0:20:35.000 better rates. They are However, some banks are losing deposits 0:20:35.000 --> 0:20:38.720 faster than other banks. Yes, I wanted you to bring 0:20:38.760 --> 0:20:42.440 this up. This is the small bank versus large bank 0:20:42.520 --> 0:20:46.159 deposit experience. And also this dovetails with a previous episode 0:20:46.680 --> 0:20:50.359 on discount lending, the discount window. I'm sorry I missed 0:20:50.400 --> 0:20:56.280 that discount window lending piece, but I think you're exactly 0:20:56.400 --> 0:21:01.480 right here, which is that the level of deposits and 0:21:01.640 --> 0:21:04.240 the level of bank reserves in the system. That is, 0:21:04.280 --> 0:21:08.720 the cash and the liquidity circulating in the system is important, 0:21:09.320 --> 0:21:13.679 but so too is the distribution of those balances across institutions. 0:21:14.359 --> 0:21:18.760 And what we're seeing is that unlike QT or quantitative 0:21:18.800 --> 0:21:25.080 tightening in twenty seventeen, the deposits are leaving right, or 0:21:25.119 --> 0:21:30.080 at least the cash is leaving small banks faster than 0:21:30.119 --> 0:21:32.880 it's leaving the large banks, and so that the smaller 0:21:32.920 --> 0:21:37.120 banks are forced to compete more aggressively in deposit markets 0:21:37.440 --> 0:21:41.280 than say they're larger banks. Now, part of this is 0:21:41.359 --> 0:21:45.280 a reflection of the fact that when QT occurred, right, 0:21:45.400 --> 0:21:50.240 deposit balance is migrated to the largest institutions out there, 0:21:50.280 --> 0:21:54.439 again because deposits are heavily concentrated, and so those banks 0:21:54.480 --> 0:21:58.560 tended to be more over deposited relatively speaking than the 0:21:58.600 --> 0:22:02.159 smaller institutions. That when the FED is braining reserves and 0:22:02.240 --> 0:22:05.879 shrinking its balance sheet, the people that have less liquidity 0:22:05.920 --> 0:22:09.080 to start off with because they had less fewer deposits, 0:22:09.119 --> 0:22:13.480 those are the institutions that are experiencing more deposit rate pressure. 0:22:15.119 --> 0:22:18.439 How do the small banks even compete? I mean, I 0:22:18.440 --> 0:22:21.040 guess rods as you say, but like, is this like 0:22:21.119 --> 0:22:24.120 going to be a permanent condition of banking. This struggle 0:22:24.200 --> 0:22:28.400 that the small banks have for deposits relative to these high, 0:22:28.560 --> 0:22:36.520 high networked large national banks. Again, you know, small banks 0:22:36.520 --> 0:22:42.360 would argue that there are you know, advantages to banking locally, 0:22:42.880 --> 0:22:46.320 and that the advantages to banking locally is, you know, 0:22:46.520 --> 0:22:52.240 your mortgage lender knows the market right, knows the housing 0:22:52.280 --> 0:22:56.800 market in your area, your commercial banker knows your business, 0:22:57.280 --> 0:23:02.800 knows your knows you personally, etc. And so there's you know, 0:23:02.840 --> 0:23:06.720 So I wouldn't say that it's inevitable that all deposits 0:23:06.720 --> 0:23:10.760 will migrate to large institutions, and large institutions will be 0:23:11.160 --> 0:23:14.280 selective and paying deposit rates. I still think that there's 0:23:14.400 --> 0:23:19.040 enough competition between large and small banks right that you know, 0:23:19.119 --> 0:23:23.159 small banks are not going away at all. But again, 0:23:23.640 --> 0:23:28.280 this deposit competition that we're experiencing right now is the 0:23:28.320 --> 0:23:32.639 aftershock of quantitative easing, right. Quantitative easing and the buying 0:23:32.640 --> 0:23:36.600 of treasury securities and mortgages again ended up putting a 0:23:36.640 --> 0:23:39.680 lot of deposits into the system as a whole. But 0:23:39.880 --> 0:23:42.879 those deposits tended to pile up faster at the larger 0:23:42.920 --> 0:23:47.080 institutions than the smaller institutions. So just on that note, 0:23:47.119 --> 0:23:49.359 and you already touched on this, but can you dig 0:23:49.400 --> 0:23:52.719 in a little bit more into what QT or quantitative 0:23:52.800 --> 0:23:58.320 tightening actually means for I guess the effectiveness of monetary 0:23:58.400 --> 0:24:02.080 policy is it does it like mechanically ramp up that 0:24:02.200 --> 0:24:08.000 competition for depositors, or does it maybe encourage some sort 0:24:08.040 --> 0:24:11.919 of substitution effect where you know, banks can I don't know, 0:24:12.359 --> 0:24:17.080 replace bank deposits with great sensitive treasuries or something like that. 0:24:18.119 --> 0:24:21.320 That's again an important distinction, and I think what you 0:24:21.400 --> 0:24:25.640 have to look at here is the demand curve or 0:24:25.840 --> 0:24:29.400 bank reserves, right. This is the liquidity that's in the system, 0:24:30.000 --> 0:24:32.879 created from quee right from the asset side of the 0:24:32.880 --> 0:24:36.040 fed's balance sheet, and these reserves are used to me 0:24:37.240 --> 0:24:43.080 int day requirements for settling payments as well as liquidity 0:24:43.119 --> 0:24:46.600 requirements for regulatory purposes that banks are required to maintain. 0:24:47.720 --> 0:24:51.000 And as the FED lets the assets on its balance 0:24:51.040 --> 0:24:55.000 sheet roll off right and doesn't replace them, so that 0:24:55.040 --> 0:24:59.760 it's balance sheet shrinks, bank reserves go down, right, and 0:25:00.080 --> 0:25:04.320 the decline in bank reserves is what forces banks right 0:25:04.440 --> 0:25:07.760 ultimately to compete more aggressively in deposit markets because they 0:25:07.800 --> 0:25:12.520 need to restore that cash position on their balance sheet. 0:25:12.560 --> 0:25:15.560 In addition to the fact that their assets growing, right, 0:25:15.560 --> 0:25:18.800 they're making loans, they need to replace that funding. The 0:25:19.040 --> 0:25:25.000 extent to which QT creates reserve pressure, right, is what 0:25:25.200 --> 0:25:27.919 creates the pressure on the FED funds rate. Right, the 0:25:27.960 --> 0:25:32.240 Fed's policy instrument and determines ultimately where the FED funds 0:25:32.320 --> 0:25:38.000 rate trades within its target band. Right. So what the 0:25:38.040 --> 0:25:40.119 FED wants to do is, if you think about the 0:25:40.200 --> 0:25:45.560 demand curve, demand curve is probably for bank reserves is 0:25:45.560 --> 0:25:50.600 probably I'm going to get this wrong concave shape, right, 0:25:50.600 --> 0:25:53.320 so it kind of caves in in the middle, and 0:25:53.400 --> 0:25:56.960 when you get to the upper part of the demand curve, right, 0:25:57.840 --> 0:26:01.119 you're in the steep slope. The steep slope of that 0:26:01.200 --> 0:26:03.760 demand curve means is that changes in the level of 0:26:03.800 --> 0:26:09.119 bank reserves creates significant changes in interest rates. And the goal, 0:26:09.640 --> 0:26:14.600 right from the Fed's perspective, is merely to shift the 0:26:14.600 --> 0:26:17.800 supply of bank reserves so that it's in the gently 0:26:17.920 --> 0:26:21.760 sloping part of the demand curve. Right, that the level 0:26:21.800 --> 0:26:26.320 of bank reserves is ample, right, but not abundant. An 0:26:26.400 --> 0:26:29.720