U.S. banks are stockpiling significant amounts of cash as a precaution against a slowing economy, ongoing deposit outflows, and impending stricter liquidity regulations that could impact mid-sized banks disproportionately.
This cautious approach is driven by the banking sector’s attempt to stabilize itself following a series of bank failures earlier in the year, which has resulted in a more risk-averse stance and the potential for constrained lending activity.
David Fanger, Senior Vice President at Moody’s rating agency, explained that this shift towards holding more cash is a sensible reaction to a decelerating economy and the need to counteract deposit outflows.
The events in March, including the collapse of Silicon Valley Bank and Signature Bank, led to massive withdrawals of deposits and a renewed emphasis on the financial stability of banks. Recent downgrades in bank ratings by S&P and Moody’s have also heightened concerns.
Federal Reserve data shows that U.S. banks’ cash assets were at $3.26 trillion as of August 23, marking a 5.4% increase from the end of 2022. Although these levels are higher than pre-pandemic figures, they have reduced from the immediate aftermath of the March bank failures.
Cash reserves at small and mid-sized banks have risen by 12% since the start of the year, while the top 25 banks in the nation have seen a more modest increase of approximately 2.9%.
Large banks like JPMorgan (NYSE:JPM) and Bank of America (NYSE:BAC) refrained from commenting on this trend, pointing instead to factors such as the Fed’s reduction of its balance sheet, declining deposits, and higher short-term interest rates.
The failure of Silicon Valley Bank in particular prompted banks to quickly accumulate cash assets within two weeks, resulting in the highest cash level since April 2022 at $3.49 trillion. Although this has moderated somewhat, it still remains almost double the pre-pandemic levels.
Higher cash reserves are necessary for banks to cover liabilities arising from customer deposit withdrawals and to mitigate risks like potential loan losses, especially as the Federal Reserve maintains elevated interest rates to control economic growth and inflation.
To bolster their financial positions, many banks are implementing measures to minimize risk and strengthen their balance sheets, a move emphasized by Brendan Browne, S&P’s Senior Credit Analyst for financial institutions.
Regional banks are reallocating more of their “earning assets,” derived from lending activities, into cash or short-term securities. Manan Gosalia, an analyst at Morgan Stanley, observed that this strategy is prompted by increasing pressure on deposit costs and a preference for higher liquidity levels. As a result, loan growth is expected to continue slowing towards the end of the year.
S&P’s forecast indicates a 2% loan growth for this year, following a nearly 9% increase in the previous year.
Furthermore, mid-sized banks are expressing concerns about impending regulatory changes. Regulatory authorities in the U.S. have indicated their intention to impose stricter capital and liquidity standards on banks with assets totaling $100 billion or more.
Since March, regulatory scrutiny has intensified, prompting banks to enhance their capabilities in liquidity and asset liability management. This change in regulatory focus has pushed banks to actively manage liquidity and the loans held on their books.
Given the Federal Reserve’s aggressive tightening measures since March 2022, longer-term securities held by banks have suffered losses, leading to concerns about the stability of bank balance sheets. Consequently, banks are adapting by reducing investments in securities or selling them at a loss.
S&P estimated that FDIC-insured banks held more than $550 billion in unrealized losses on their available-for-sale and held-to-maturity securities as of June 30.
Bank of America disclosed that it sold $93 billion of available-for-sale securities in the first two quarters of the year, adding the proceeds to its cash reserves, which stood at $374 billion at the end of June. The bank’s cash holdings, invested in money markets, have yielded better returns than low-yielding securities.
JPMorgan, a larger player in the industry, has been selling securities for a year, with $420 billion in cash and $990 billion in high-quality liquidity assets and other unencumbered securities.
The prevailing high short-term interest rates are incentivizing banks to reinvest their cash holdings opportunistically in short-term securities, which is viewed as advantageous given the current financial landscape.