WEBVTT - Josh Younger Explains How Banks Really Manage Rate Risk 0:00:09.960 --> 0:00:13.320 Hello, and welcome to another episode of The Oddlots Podcast. 0:00:13.440 --> 0:00:14.880 I'm Tracy Alloway. 0:00:14.560 --> 0:00:16.360 And I'm joll Why isn't thal Joe? 0:00:16.360 --> 0:00:19.200 What do you know about the dark arts of asset 0:00:19.239 --> 0:00:20.320 liability management? 0:00:22.160 --> 0:00:24.640 Only things that have been told to us about it 0:00:24.680 --> 0:00:25.880 on the Odd Lots. O. 0:00:25.960 --> 0:00:27.160 Wait, that's actually quite a lot. 0:00:27.280 --> 0:00:31.240 Yeah, No, that's true. It seems tough. Deposits can be flighty, 0:00:31.360 --> 0:00:34.959 sometimes they can be stable. Sometimes when rates go up 0:00:34.960 --> 0:00:38.440 they get passed on to deposits. Sometimes they don't deposit. 0:00:38.479 --> 0:00:44.640 Beta's change over time, some things that. Yeah, that's about Okay, 0:00:44.640 --> 0:00:45.199 that's about it. 0:00:45.320 --> 0:00:48.920 No, that's pretty good. Podcast over, We're done, podcast over. No, 0:00:49.360 --> 0:00:52.920 you're absolutely right about your characterization of deposits. And I 0:00:52.920 --> 0:00:55.440 think one of the really interesting things about banking is 0:00:55.520 --> 0:00:58.560 it is kind of built on this tension, which is 0:00:58.600 --> 0:01:02.200 that in theory, you know, I can put my money 0:01:02.320 --> 0:01:05.440 in a bank as a deposit, and then I am 0:01:05.720 --> 0:01:10.560 theoretically entitled to pull it out at any time, And I, 0:01:10.720 --> 0:01:14.839 for one, can't really imagine a business where like, at 0:01:15.040 --> 0:01:17.800 any single point, I could see a majority of my 0:01:17.880 --> 0:01:22.200 customers suddenly vanish. But it is also true in practice 0:01:22.880 --> 0:01:25.559 that people who put their money in banks, they don't 0:01:25.600 --> 0:01:28.120 tend to move it around that much. And that is 0:01:28.160 --> 0:01:32.720 the thing, like the magic behavior that enables banks to 0:01:32.959 --> 0:01:37.959 actually lend money or buy assets like bonds and things 0:01:38.000 --> 0:01:38.320 like that. 0:01:38.880 --> 0:01:41.880 Yeah, and you know, obviously part of the reason anyone 0:01:41.959 --> 0:01:44.800 is having this conversation still is we all have we 0:01:45.480 --> 0:01:49.400 remember this past March with SVB, but I recall at 0:01:49.400 --> 0:01:52.680 the time and some of our episodes around them, thinking 0:01:52.680 --> 0:01:55.880 about how I don't know if paradox is the word, 0:01:56.160 --> 0:01:59.200 funny is the word, or weird it is that on 0:01:59.480 --> 0:02:04.920 some bank deposits are extremely sticky and long duration, and 0:02:05.080 --> 0:02:07.280 I think, you know, there's that stat maybe it's fake, 0:02:07.400 --> 0:02:10.560 but you know, people are more likely to get divorced 0:02:10.560 --> 0:02:12.760 than leave a bank, is one of those things that 0:02:12.760 --> 0:02:15.080 people say. And if you have a customer, that's great. 0:02:15.400 --> 0:02:18.800 On the other hand, sometimes the deposits do leave and 0:02:18.840 --> 0:02:21.520 can leave in five seconds and it doesn't take very much. 0:02:21.720 --> 0:02:24.200 So it always seemed to me that rather, I'm like, 0:02:24.240 --> 0:02:27.200 I wonder our deposits do they exist on some continuum 0:02:27.240 --> 0:02:30.200 of sticky to long duration or do they are Is 0:02:30.240 --> 0:02:34.799 it more like Schrodinger's Schrodinger's deposits either they're there or 0:02:34.840 --> 0:02:37.600 they're not there, but that there's no sort of in between. 0:02:37.680 --> 0:02:37.920 Stay. 0:02:38.320 --> 0:02:41.359 Yeah. We did that great episode with Joe Abat over 0:02:41.400 --> 0:02:45.360 at Barclay's about bank deposits, and we've been joking on 0:02:45.440 --> 0:02:48.799 the podcast since that in order to improve the transmission 0:02:48.840 --> 0:02:51.440 of monetary policy, everyone needs to go out, do their 0:02:51.480 --> 0:02:56.120 market research, find a high paying bank account somewhere and 0:02:56.240 --> 0:02:59.360 actually move their money. And you know, I am joking, 0:02:59.480 --> 0:03:03.800 but also kind not. There is an interaction between banks 0:03:04.000 --> 0:03:08.000 and deposit rates and the effective transmission to monetary policy. 0:03:08.040 --> 0:03:11.160 I mean, banks are supposed to be the primary mechanism 0:03:11.200 --> 0:03:14.680 through which a lot of monetary policy is transmitted, and 0:03:14.760 --> 0:03:19.400 so the question of how deposits are actually working, so 0:03:19.560 --> 0:03:22.880 whether or not they're sticky, whether or not that stickiness 0:03:23.000 --> 0:03:27.280 changes in an environment where rates are going up or down, 0:03:27.760 --> 0:03:32.000 and also how those deposits sort of feed into monetary policy. 0:03:32.800 --> 0:03:34.679 That is a really big topic and I think we 0:03:34.680 --> 0:03:36.400 should do more on it totally. You know. 0:03:36.440 --> 0:03:38.760 The thing that really strikes me, and this is in 0:03:39.320 --> 0:03:43.280 a bank run is the perfect example of nonlinearity, right, 0:03:43.320 --> 0:03:46.560 and so something is one state and then something is 0:03:46.600 --> 0:03:50.000 suddenly a very different state. And we went from and 0:03:50.200 --> 0:03:54.520 I think we've learned in recent times how tricky that 0:03:54.640 --> 0:03:57.840 is to manage, and I think understanding the actual management 0:03:57.880 --> 0:04:01.720 of that nonlinearity in practice something we can dive into further. 0:04:01.680 --> 0:04:03.800 Right And I did call it the dark art of 0:04:03.920 --> 0:04:07.760 asset liability management at the opening, and to some extent 0:04:07.840 --> 0:04:10.280 it is kind of opaque, like no one gets a 0:04:10.280 --> 0:04:13.680 lot of transparency into how an individual bank is actually 0:04:13.720 --> 0:04:17.520 managing things like deposit and interest rate risk. So I'm 0:04:17.520 --> 0:04:19.960 glad we can do this episode, and more than that, 0:04:20.040 --> 0:04:22.640 we are really doing it with the perfect guest. We 0:04:22.720 --> 0:04:25.680 have someone who's been on All Blots many times. 0:04:25.720 --> 0:04:28.560 He's now climbing the rank really one, don't you think, 0:04:28.600 --> 0:04:31.400 I mean of the moment must be he's up there. 0:04:31.600 --> 0:04:33.640 Yeah, all right, So we're going to be speaking to 0:04:33.880 --> 0:04:37.840 one of our perennial favorite guests, Josh Younger, formerly of 0:04:37.960 --> 0:04:41.400 JP Morgan, now a senior advisor over at the Federal 0:04:41.440 --> 0:04:44.359 Reserve Bank of New York. Josh, thank you for coming 0:04:44.480 --> 0:04:47.840 back on All Blots for like the fifth sixth time. 0:04:47.920 --> 0:04:50.479 I don't know, I've lost count, but it's great to 0:04:50.480 --> 0:04:53.080 be back. I really appreciate the opportunities. It's great to 0:04:53.080 --> 0:04:53.760 talk about. 0:04:53.520 --> 0:04:56.400 This and I should just mention that we're recording this 0:04:56.560 --> 0:05:01.520 on November ninth, and Josh, you have something to say 0:05:01.560 --> 0:05:02.239 to our audience. 0:05:02.560 --> 0:05:05.760 Yes, I almost memorized it, but we'll see. We'll see 0:05:05.760 --> 0:05:07.680 if I get all the parts right. But these views 0:05:07.720 --> 0:05:10.080 are my own, and those are my co authors from 0:05:10.120 --> 0:05:12.440 the paper that we wrote, and they don't necessarily reflect 0:05:12.440 --> 0:05:15.200 the views of the Federal Reserve System, the Federalser Bank 0:05:15.200 --> 0:05:17.160 of New York, or the federalzer Bank of Dallas. 0:05:17.240 --> 0:05:19.840 Oh yeah, I should mention that. I mean I kind 0:05:19.839 --> 0:05:22.360 of figured that Josh would be an expert on this anyway. 0:05:22.560 --> 0:05:24.440 But one of the reasons we wanted to talk to 0:05:24.480 --> 0:05:28.400 him is because he did just publish a paper at 0:05:28.400 --> 0:05:32.920 the Federal Reserve Bank of Dallas called Deposit Convexity, Monetary Policy, 0:05:32.960 --> 0:05:36.039 and Financial Stability, and it gets into the nuts and 0:05:36.080 --> 0:05:38.320 bolts of all the themes that Joe and I were 0:05:38.360 --> 0:05:42.160 just discussing in the intro. So, speaking of the paper, 0:05:42.279 --> 0:05:45.160 I mean, one of the things that you mentioned in 0:05:45.200 --> 0:05:49.560 the research is that you and your authors have sort 0:05:49.560 --> 0:05:54.480 of personal experience with the way banks actually deal with 0:05:54.600 --> 0:05:56.800 interest rate risk. Can you talk to us a little 0:05:56.800 --> 0:06:01.360 bit about how banks typically manage like, how are they 0:06:01.400 --> 0:06:06.200 thinking about things like deposits and interest rate exposure. 0:06:06.520 --> 0:06:09.359 Yeah, so it's very tempting. I mean, Joe you were 0:06:09.400 --> 0:06:12.280 saying earlier. The deposits are there until they're not. And 0:06:12.760 --> 0:06:15.520 but they're also an overnight demandable liability, meaning you can 0:06:15.520 --> 0:06:17.800 get your money back whenever you want your money back, 0:06:17.839 --> 0:06:21.279 and you tend not to. So it's a very behavioral process, 0:06:22.160 --> 0:06:24.279 and so a lot of the work of managing the 0:06:24.320 --> 0:06:28.000 interest rate risk of a bank is really understanding that 0:06:28.080 --> 0:06:33.000 behavior because deposits are typically by far the largest source 0:06:33.040 --> 0:06:36.039 of funding for most banks. Depending on the kind of 0:06:36.040 --> 0:06:37.680 banking you're doing, you might have more or less of it, 0:06:37.720 --> 0:06:41.880 but it's typically a huge chunk and it's not something 0:06:41.960 --> 0:06:43.560 you can I mean, we made an attempt to write 0:06:43.560 --> 0:06:46.159 it down on paper, but it's all based on the 0:06:46.200 --> 0:06:48.960 premise that people tend to leave their money at banks 0:06:48.960 --> 0:06:52.080 for long periods of time, even if that interest rate 0:06:52.160 --> 0:06:54.920 is below what the broader market would consider risk free. 0:06:54.880 --> 0:06:56.559 You know, there's lots of reasons for that. You certainly 0:06:56.640 --> 0:06:59.080 need bank deposits to like, live your life, right, So 0:06:59.080 --> 0:07:01.440 people usually call this convenience yield because you use bank 0:07:01.480 --> 0:07:04.440 deposits for actual transactions as opposed to like money market 0:07:04.440 --> 0:07:08.200 fund shares, which you don't. But if as a bank 0:07:08.240 --> 0:07:10.240 you have one set of liabilities, you have to understand 0:07:10.880 --> 0:07:14.080 and then on the asset side sometimes there's there's some complexity, 0:07:14.080 --> 0:07:17.760 like mortgages are relatively complex. Lots of loans have embedded 0:07:17.840 --> 0:07:20.320 quote unquote options, meaning the floors and caps and things 0:07:20.360 --> 0:07:22.559 like that, but those are sort of easier to model 0:07:22.560 --> 0:07:25.280 from first principles like financial math perspective, and so you 0:07:25.360 --> 0:07:28.200 have a pretty good understanding of the interest rate risk 0:07:28.320 --> 0:07:30.680 on the light on the asset side of the portfolio, 0:07:31.000 --> 0:07:33.120 and a lot of the legwork is spent understanding the 0:07:33.120 --> 0:07:35.440 liability side, specifically deposits. 0:07:35.360 --> 0:07:38.240 In light of that. So Tracy mentioned we talked to 0:07:38.680 --> 0:07:41.800 we did an episode with Joel Bote over at Barclays, 0:07:41.880 --> 0:07:44.240 and that was just a few weeks before SVB, and 0:07:44.280 --> 0:07:47.000 we didn't know there was no intention, But the question 0:07:47.200 --> 0:07:50.480 then was, well, rate hikes have gone up or sorry, 0:07:50.840 --> 0:07:53.440 rates have gone up. By then at that point, the 0:07:53.480 --> 0:07:56.480 Fed had done a ton of hiking. And yet you know, 0:07:56.560 --> 0:08:00.440 you look around and deposit rates are of the rates 0:08:00.480 --> 0:08:03.480 that banks were paying out on people's deposits hadn't gone 0:08:03.560 --> 0:08:06.600 up that more so we explored this idea of deposit 0:08:06.640 --> 0:08:10.720 beta in your research, what is what can we say 0:08:11.520 --> 0:08:14.640 in just based on your research about the nature of 0:08:15.280 --> 0:08:19.120 how banks time the passing along of higher rates, So 0:08:19.280 --> 0:08:21.040 it brings up kind of the mechanism which as we 0:08:21.040 --> 0:08:23.760 talk about this beata, what does it represent? 0:08:23.840 --> 0:08:25.920 Why does it move? Because there's a temptation to think 0:08:26.320 --> 0:08:28.880 there's one big book of deposits and a giant lever 0:08:29.000 --> 0:08:30.040 somewhere in the bank. 0:08:30.160 --> 0:08:32.840 We should just say so beta is like the degree 0:08:32.880 --> 0:08:34.319 to which these two things are moving. 0:08:34.360 --> 0:08:34.680 Intent. 0:08:35.080 --> 0:08:37.840 So benchmark interest rates going up, are rates paid out 0:08:37.880 --> 0:08:40.640 on retail bank deposits or other types of bank deposits 0:08:40.679 --> 0:08:41.360 actually going up. 0:08:41.440 --> 0:08:43.440 Yeah. So if a quote unquote market yields the yield 0:08:43.440 --> 0:08:45.120 you would get from money market fund for example, are 0:08:45.120 --> 0:08:46.959 close to that goes up by one hundred basis points, 0:08:46.960 --> 0:08:50.400 how much of that is represented in your deposit rate paid? 0:08:50.600 --> 0:08:52.520 As a bank you think bank thinks about paying our 0:08:52.640 --> 0:08:55.680 interest on deposits, so we call it rate paid, But 0:08:55.920 --> 0:08:58.040 obviously the depositor is getting paid that interest. It's the 0:08:58.120 --> 0:09:00.880 rate you earn. And a beta to a twenty five 0:09:00.920 --> 0:09:02.840 percent would mean for ever one hundred basis points or 0:09:02.840 --> 0:09:06.360 one percentage move in market yield twenty five basis points 0:09:06.440 --> 0:09:09.200 or a quarter of a percentage point is actually reflected 0:09:09.400 --> 0:09:13.160 in the deposit rate. So you know, the teendation is 0:09:13.200 --> 0:09:15.040 to say, well, there's just this big book of deposits. 0:09:15.040 --> 0:09:17.680 There's a giant dial somewhere in the bank, and you know, 0:09:17.720 --> 0:09:19.800 you kind of move the dial less than the market 0:09:19.840 --> 0:09:23.680 yield moved, and you do that to achieve some business outcome. 0:09:24.840 --> 0:09:27.280 And there's sort of two things to think about with that. 0:09:27.320 --> 0:09:31.160 The first is that the actual beta, the changes in 0:09:31.280 --> 0:09:34.280 beta or the level of the beta, is to a 0:09:34.320 --> 0:09:37.440 great extent the consequence of the deposit mix, meaning how 0:09:37.480 --> 0:09:39.520 much of these things are in time deposit certificates of 0:09:39.559 --> 0:09:42.520 deposit things with term exposure, and how much of that 0:09:42.720 --> 0:09:45.720 is let's say zero interest checking And so as. 0:09:45.920 --> 0:09:48.800 Demand deposits, they're called right where you can withdraw them 0:09:49.160 --> 0:09:51.079 anytime when you want on demand. 0:09:51.160 --> 0:09:53.040 Yeah, so you can say I want a demand deposit account. 0:09:53.040 --> 0:09:54.520 I want to get my money whenever I want, or 0:09:54.559 --> 0:09:57.080 you say I'll get my money in three months and 0:09:57.200 --> 0:09:58.920 I want to earn a slightly higher rate of interest 0:09:58.920 --> 0:10:02.240 for that. And typically those time deposits are priced at 0:10:02.280 --> 0:10:06.560 some spread or difference to the market yield and demand 0:10:06.559 --> 0:10:08.960 deposits typically a very low interest rate, and so as 0:10:09.600 --> 0:10:13.200 customers move from demand deposits to time deposits, there's naturally 0:10:13.240 --> 0:10:17.160 more reactivity just because they're terming out their deposits. So 0:10:17.160 --> 0:10:19.400 that's one source of behavior. And then there is to 0:10:19.440 --> 0:10:23.800 some extent a dial that reflects savings and checking account rates, 0:10:23.840 --> 0:10:26.360 particularly on the institutional side, so the rate's paid to 0:10:26.880 --> 0:10:30.719 corporations and investment managers and things like that, who tend 0:10:30.760 --> 0:10:33.120 to be much more sensitive to these economic considerations. They 0:10:33.200 --> 0:10:35.240 leave a lot more money on the table basically when 0:10:35.280 --> 0:10:39.000 deposit rates are incrementally higher or lower. And in that case, 0:10:39.080 --> 0:10:41.200 the question is do I want to grow my business 0:10:41.280 --> 0:10:43.720 or shrink my business or keep it the same. So 0:10:43.760 --> 0:10:46.600 there's kind of a debate when you're talking about a beta. 0:10:46.679 --> 0:10:49.240 Are you talking about the market neutral beta meaning my 0:10:49.360 --> 0:10:51.880 market share to say is constant? Are you talking about 0:10:51.960 --> 0:10:54.440 the beta re car to grow my business? You're talking 0:10:54.440 --> 0:10:56.360 about betaver card to shrink my business. There's been a 0:10:56.400 --> 0:10:59.960 lot of discussion about how size can sometimes be more expensive, 0:11:00.080 --> 0:11:02.760 not more profitable, and so you might want to shrink 0:11:02.800 --> 0:11:06.280 a business for example. And so when we think about 0:11:06.400 --> 0:11:08.440 topics around interest rate risk management. I always like to 0:11:08.440 --> 0:11:10.320 think in terms of the sort of market neutral beta, 0:11:10.320 --> 0:11:12.640 which is what is the market beta I need to 0:11:12.679 --> 0:11:15.520 pay to keep all the deposits I currently have, or 0:11:15.559 --> 0:11:17.640 at least my share of the deposits in the system, 0:11:17.679 --> 0:11:21.280 because that's more reflective of like the actual underlying interest 0:11:21.320 --> 0:11:24.680 rate risk of deposit liabilities as opposed to the business 0:11:24.760 --> 0:11:39.360 management and planning decisions of an individual institution. 0:11:44.679 --> 0:11:47.600 Getting back to the idea that you know, in theory, 0:11:47.800 --> 0:11:51.000 people can pull their money out of banks whenever they want, 0:11:51.120 --> 0:11:54.200 unless they're in something like a certificate of deposit. But 0:11:54.400 --> 0:11:57.520 in practice they tend not to. And I remember this 0:11:57.600 --> 0:12:01.160 is something we spoke to Abata about, Like there are 0:12:01.240 --> 0:12:04.520 a lot of people who have an account at a 0:12:04.559 --> 0:12:07.439 specific bank because they're getting something else out of it. 0:12:07.559 --> 0:12:10.120 You know, there's a relationship there, a business relationship, they 0:12:10.160 --> 0:12:12.640 know each other, maybe they're getting a loan, a business 0:12:12.679 --> 0:12:17.040 loan or something like that. How sticky are deposits in practice? 0:12:17.160 --> 0:12:21.360 And does it vary by you know, deposit type beyond 0:12:21.440 --> 0:12:25.320 whether it's a demand deposit versus a termed out depositive. 0:12:25.400 --> 0:12:28.640 Yeah, the type of depositor is really important. And so 0:12:29.320 --> 0:12:31.000 you know, maybe taking a big step back. So think 0:12:31.040 --> 0:12:32.760 about the system as a whole. Why do we think 0:12:32.760 --> 0:12:35.200 deposits are long lived? If you go back to the 0:12:35.240 --> 0:12:38.360 state banking here of the eighteen thirties and go all 0:12:38.360 --> 0:12:40.600 the way to today, for most of that period, deposit 0:12:40.640 --> 0:12:43.480 balances are growing at or faster than gross domestic product, 0:12:43.480 --> 0:12:45.800 which tells you that the deposits in the system as 0:12:45.800 --> 0:12:48.640 a system are there for the most part. Now there 0:12:48.640 --> 0:12:51.560 are more outlets now than there were back then. To 0:12:51.640 --> 0:12:53.480 leave the banking system, go to see money market fund 0:12:53.480 --> 0:12:55.840 There certainly weren't money market funds in the eighteen fifties. 0:12:55.880 --> 0:12:59.560 But like generally speaking, deposits tend to grow with or 0:12:59.600 --> 0:13:02.480 faster and GDP. So even if you take your deposit 0:13:02.520 --> 0:13:04.400 out of one bank, you're probably putting it at another bank. 0:13:04.480 --> 0:13:07.320 So deposits in the system are very long lived. But 0:13:07.360 --> 0:13:09.400 then there's a question of the type of depositor and 0:13:09.440 --> 0:13:12.880 so on the one hand, of what we call retail depositors, 0:13:12.920 --> 0:13:15.760 I'm just using liquidity coverage ratio terminology. This is what 0:13:15.800 --> 0:13:19.320 the regulators have used to establish different types of deposits. 0:13:19.360 --> 0:13:22.640 So there's a common language for this now. Retail or 0:13:22.720 --> 0:13:26.800 stable retail deposits are you know, individuals, like people at 0:13:26.840 --> 0:13:30.679 this table, we tend to be relatively insensitive to rates 0:13:30.840 --> 0:13:33.680 on the whole because we use our deposits for for 0:13:33.720 --> 0:13:35.520 the most part, for lots of stuff. So we go 0:13:35.600 --> 0:13:38.040 buy coffee with it, and we go to the movies 0:13:38.160 --> 0:13:41.280 or whatever, like you pay your pay your gas bill. 0:13:41.320 --> 0:13:43.720 Even if it's direct deposit from your bank account, it's 0:13:43.720 --> 0:13:45.640 still from a bank account. It's not from a money 0:13:45.640 --> 0:13:48.440 market fund. And so you know, the convenience yield, so 0:13:48.480 --> 0:13:51.120 to speak, of having bank deposits is relatively high. And 0:13:51.720 --> 0:13:54.040 even if most people don't keep a lot of money 0:13:54.080 --> 0:13:55.400 at the bank, there are a lot of people and 0:13:55.440 --> 0:13:57.280 so that adds up to a big deposit base. So 0:13:57.720 --> 0:13:59.760 most of the useful money in the economy is in 0:14:00.040 --> 0:14:03.920 posit format used by individuals. And then if you go 0:14:04.400 --> 0:14:06.240 so that, we call that a low beta deposit or 0:14:06.240 --> 0:14:08.880 a sticky deposit. And that's again a statement about the 0:14:08.960 --> 0:14:12.640 rate paid, not necessarily the propensity for that deposit to 0:14:12.760 --> 0:14:14.560 leave the bank. We can talk about that separately, but 0:14:14.600 --> 0:14:17.280 this is assuming I pay whatever rate is necessary to 0:14:17.400 --> 0:14:21.560 keep that deposit. So that's a relatively low beta, low 0:14:21.640 --> 0:14:24.760 rate deposit. Not much reactivity to market yield. And then 0:14:24.800 --> 0:14:27.800 if you go into what the regulations term the wholesale space, 0:14:27.840 --> 0:14:31.720 wholesale deposit space, which is really institutions, asset managers who 0:14:31.760 --> 0:14:36.280 have excess cash, corporations who have excess cash. They kind 0:14:36.320 --> 0:14:38.080 of split it into two buckets. One is what it's 0:14:38.080 --> 0:14:42.240 called operational deposits. Operational are used to meet payroll and 0:14:42.480 --> 0:14:45.040 various expenses. If you import export, you have to pay 0:14:45.040 --> 0:14:48.120 somebody with that deposit, and so those still need to 0:14:48.160 --> 0:14:50.400 be in the banking system somewhere. Now you can move 0:14:50.400 --> 0:14:53.600 them around between banks, but the rate paid on those 0:14:53.640 --> 0:14:57.240 tends to be a little lower than market yields, for example, 0:14:57.360 --> 0:14:59.760 just because they still need to be a bank deposit 0:14:59.760 --> 0:15:00.960 at the s end of the day, so there's still 0:15:00.960 --> 0:15:03.960 a convenience yield, so to speak, to have that. And 0:15:04.000 --> 0:15:05.680 then at the high beta end of the spectrum, you 0:15:05.680 --> 0:15:09.400 have non operational deposits, which is excess cash that's being 0:15:09.480 --> 0:15:11.880 left in a deposit account for or reasons on known 0:15:11.920 --> 0:15:13.560 it could easily go to a money market fund. It's 0:15:13.560 --> 0:15:19.000 money that corporations don't need to meet regular payroll and expenses, 0:15:19.040 --> 0:15:22.240 and so they're kind of keeping it because it's convenient 0:15:22.280 --> 0:15:25.320 to have some excess savings just in case maybe or 0:15:25.360 --> 0:15:27.720 something like that, but it's not being used on a 0:15:27.800 --> 0:15:29.880 daily basis, So in principle it could be in anything. 0:15:30.120 --> 0:15:33.400 It's more of an investment in deposit accounts. So to 0:15:33.520 --> 0:15:36.000 keep those funds you need to pay a relatively high 0:15:36.080 --> 0:15:38.920 data pretty close to one because otherwise they'll just go 0:15:38.920 --> 0:15:40.400 somewhere else or to a money market fund. 0:15:40.920 --> 0:15:44.280 What happens when the FED embarks on and we've had 0:15:44.960 --> 0:15:49.600 we had this hiking cycle. Maybe it's over pass hiking cycles. 0:15:49.920 --> 0:15:53.680 What is your research show really happens to deposit betas 0:15:53.720 --> 0:15:56.360 over time as a hiking cycle picks up. 0:15:56.480 --> 0:15:58.680 Yeah, So here we're thinking about the consolidated beta of 0:15:58.760 --> 0:16:01.480 the whole institutions. This is if you take whatever fraction 0:16:01.600 --> 0:16:05.000 you have in retail, wholesale, operational, wholesale, non operational, and 0:16:05.040 --> 0:16:07.000 even wholesale funding and term funding. You just think of 0:16:07.040 --> 0:16:10.480 the funding rate the bank has to pay to fund itself. 0:16:11.360 --> 0:16:13.760 That beta, just the ratio of that rate to the 0:16:13.840 --> 0:16:18.320 risk free overnight rate tends to increase as interest rates rise. 0:16:18.360 --> 0:16:23.240 So this is related to the propensity of corporations in particular, 0:16:23.240 --> 0:16:25.760 but also individuals to move their excess savings into money 0:16:25.760 --> 0:16:27.880 market funds when interest rates are above zero and the 0:16:27.880 --> 0:16:31.680 opportunity cost of keeping them in a bank increases. That's 0:16:31.720 --> 0:16:35.560 not true for everybody, but on average and over the 0:16:35.560 --> 0:16:37.960 long sweep of history, it's tended to be the case 0:16:38.560 --> 0:16:42.800 that the beta goes up when rates go up. 0:16:42.840 --> 0:16:46.160 Wait, so this is different to how people normally think 0:16:46.360 --> 0:16:50.080 of the way bank deposit rates work, which is people 0:16:50.120 --> 0:16:52.440 tend to think of them as like a linear thing, 0:16:52.640 --> 0:16:54.800 like rates go up one hundred basis points, and then 0:16:54.960 --> 0:16:57.200 deposits will go up one hundred basis points. Maybe not 0:16:57.240 --> 0:17:00.200 one hundred exactly for obvious reasons that we've discovered on 0:17:00.240 --> 0:17:03.360 the podcast, but by yeah, but by like a set 0:17:03.440 --> 0:17:06.879 amount each time. But you're kind of arguing that actually 0:17:06.920 --> 0:17:09.760 it's a non linear relationship and as interest rates go up, 0:17:09.880 --> 0:17:12.160 the beta the relationship actually gets stronger. 0:17:12.320 --> 0:17:15.359 Yeah, exactly. So, like linear means is static beta. Static 0:17:15.400 --> 0:17:17.840 beta means twenty five percent of every interest rate increase 0:17:17.880 --> 0:17:20.720 goes through to deposits, for example. And so if that 0:17:20.720 --> 0:17:24.560 beta increases, non linear relationship starts turning up and getting 0:17:24.600 --> 0:17:28.200 some convexity to it, and that means that the last 0:17:28.240 --> 0:17:29.920 hundred basis points are not the same as the first 0:17:30.040 --> 0:17:32.879 hundred basis points, for example, from the depositors perspective. 0:17:33.280 --> 0:17:36.560 So on that note, you mentioned money market funds. Just 0:17:36.640 --> 0:17:39.680 then like how much of this dynamic is driven by 0:17:39.800 --> 0:17:42.879 competition with money market funds, Because if I think about 0:17:42.920 --> 0:17:46.720 like things that have changed in the financial system, it 0:17:46.840 --> 0:17:50.680 feels like MMFs are a bigger presence, although maybe they're 0:17:50.720 --> 0:17:52.359 not compared to two thousand and eight, I can't remember 0:17:52.359 --> 0:17:55.840 the numbers, but it feels like nowadays there is this 0:17:56.000 --> 0:17:58.160 range of options for where you want to put your 0:17:58.160 --> 0:18:00.920 excess cash, and we have seen in flows to money 0:18:00.920 --> 0:18:03.560 market funds pick up. We have seen that play a 0:18:03.640 --> 0:18:08.560 role in things like SVB and silver Gate obviously or sorry, arguably. 0:18:08.760 --> 0:18:11.399 So I'm just wondering, like, how do banks compete with 0:18:11.520 --> 0:18:14.560 MMFs and how does that feed into that non linear 0:18:14.720 --> 0:18:16.720 relationship that you just describe. 0:18:16.840 --> 0:18:19.600 So they're competing primarily with each other. I would argue, 0:18:19.640 --> 0:18:21.840 like a bank has expenses that a money market fund 0:18:21.880 --> 0:18:25.399 does not, namely capital and liquidity, and so you know, 0:18:25.480 --> 0:18:28.679 money market funds are essentially a pass through instrument, and 0:18:28.760 --> 0:18:33.360 so they don't have branches, they don't have payment processing services, 0:18:33.359 --> 0:18:35.119 they don't have all of the overheaded bank deals with 0:18:35.240 --> 0:18:37.119 so it's kind of a it's number to think that 0:18:37.119 --> 0:18:38.840 a bank could quote unquote compete with the money f 0:18:38.880 --> 0:18:41.280 I'm purely on the yield that they offer because it's 0:18:41.320 --> 0:18:42.920 a very different business. 0:18:42.520 --> 0:18:44.159 Right, But this is what I mean, Like, banks are 0:18:44.160 --> 0:18:46.439 always going to have expenses, so they're always going to 0:18:46.560 --> 0:18:48.880 have to pay out less than a money market fund, 0:18:48.880 --> 0:18:50.520 Like they won't be able to pass on that full 0:18:50.560 --> 0:18:51.600 interest rate hike. 0:18:51.760 --> 0:18:54.080 Right generally speaking, yes, and now they can compete with 0:18:54.119 --> 0:18:56.439 each other, and they could try to source deposits that 0:18:56.520 --> 0:18:59.639 have they're associated with profitable activities. So we haven't really 0:18:59.640 --> 0:19:02.440 talked about what you're using these deposits for. If using 0:19:02.440 --> 0:19:04.720 them to just hold excess cash, it's probably less attractive. 0:19:04.720 --> 0:19:09.000 If you have businesses like wealth management and market making 0:19:09.080 --> 0:19:12.879 trading that generate non interest revenue, it might be more interesting, 0:19:12.960 --> 0:19:14.800 but you have to have something to do with the funding. 0:19:15.640 --> 0:19:18.600 But and that's why in some cases banks we're very 0:19:18.640 --> 0:19:21.679 happy to see these deposits roll off. And when you 0:19:21.680 --> 0:19:25.520 have non operational deposits supporting cash holdings, there's not much 0:19:25.560 --> 0:19:28.520 spread in that you still have all of the expenses, 0:19:28.640 --> 0:19:32.159 so you have a relatively high interest deposit funding to 0:19:32.280 --> 0:19:37.200 support non spread earning cash assets, and like that's really 0:19:37.240 --> 0:19:38.760 not what they're in the business of doing. And so 0:19:38.880 --> 0:19:42.879 under those circumstances, higher rates and money market fund runoff 0:19:42.880 --> 0:19:47.160 to money market funds is like reasonably fine. But then again, 0:19:47.200 --> 0:19:49.520 if you have you know, again, very profitable businesses that 0:19:49.600 --> 0:19:52.000 need funding, you want to you want to bid to 0:19:52.080 --> 0:19:54.720 retain that funding, because otherwise you have to shrink the business. 0:19:54.800 --> 0:19:56.760 And so I would think of this as more of 0:19:57.119 --> 0:19:59.200 to some extent, commuting with money funds, but also banks 0:19:59.200 --> 0:20:02.080 competing with each other for those marginal deposits that support 0:20:02.119 --> 0:20:03.080 profitable activity. 0:20:03.440 --> 0:20:05.199 Joe, do you remember, I think it must have been 0:20:05.280 --> 0:20:07.360 just a couple of years ago when banks were complaining 0:20:07.359 --> 0:20:08.560 about access deposits. 0:20:08.840 --> 0:20:11.399 Absolutely for one thing. Yeah, absolutely, and it was it 0:20:11.440 --> 0:20:14.119 was always sort of. It took me actually many odd 0:20:14.320 --> 0:20:18.159 Loots episodes to even understand the coherence of that statement. 0:20:18.560 --> 0:20:22.080