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Banks' golden deposits are heading out the door

The Wall Street Journal. logo The Wall Street Journal. 10/23/2018 Rachel Louise Ensign

There’s less free money to go around for banks.

After nearly three years of rate increases from the Federal Reserve, customers are pulling billions of dollars out of accounts that don’t earn interest and putting their money into higher-yielding alternatives. That will crimp banks’ ability to grow profits going forward.

The four largest U.S. banks—JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc.—reported a combined 5% drop in U.S. deposits that earn no interest in the third quarter compared with a year ago. Customers withdrew more than $30 billion from U.S. bank accounts that don’t earn interest over the year that ended June 30, the first such annual decline in more than a decade, according to Federal Deposit Insurance Corp. data.

These deposits largely consist of business and consumer checking accounts and are considered particularly valuable because banks can use these no-cost deposits to make loans. As short-term interest rates rise, they become even more lucrative.

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Although the Fed started raising short-term rates in December 2015, banks have been able to boost earnings by charging higher rates on loans while still paying depositors nearly nothing. But after eight incremental Fed increases, some customers are moving their money to capture higher yields elsewhere, threatening future gains in bank profits.

Deposits that earn no interest are “the crown jewel of the bank funding base,” said Allen Tischler, a senior vice president at Moody’s Investors Service. “You start losing that and you end up not being able to benefit from future rate increases.”

Before the financial crisis, noninterest bearing deposits made up a much smaller portion of money at banks. In 2007, the Fed started cutting interest rates in an effort to combat mounting economic problems. The central bank left them near zero for seven years in an unprecedented move.

For many individual depositors, rates were so low for so long on money-market and savings accounts across the industry that they opted to keep their money in checking accounts that earned nothing at all.

Noninterest deposits also became more attractive to corporate customers because the government offered unlimited insurance for many of these in the years after the crisis. Another incentive for corporate customers: They often earn credits to cover fees on other bank products when they put money in noninterest accounts. With rates so low, those credits were often worth more than they would have earned in an interest-bearing account.

When the Federal Reserve started raising rates in December 2015, bank profits quickly benefited. That was because lenders started charging more on certain loans like credit cards and lines of credit to businesses, but didn’t immediately pay depositors more.

Slowly, lenders started paying higher rates to some savvy corporate and wealth-management customers who might otherwise take their money elsewhere. Still, money in noninterest accounts continued to grow.

That is now reversing, even if slowly. Noninterest deposits of around $3.2 trillion were equal to 26.3% of domestic deposits at U.S. banks in the second quarter, according to FDIC data. Although way above precrisis levels, the ratio is down from 27.5% a year ago. That equates to about $30.6 billion less in noninterest accounts.

The push for a better deposit deal is coming mostly from businesses, which have more to gain because of their large amounts of cash. Lenders including Bank of America, JPMorgan and regional lender PNC Financial Services Group Inc. all said on earnings calls that business customers moved money from accounts that earn zero interest into accounts that pay more in the third quarter.

Bank of America, for instance, said average corporate noninterest deposits fell 11% in the third quarter compared with a year earlier. Meanwhile, corporate deposits that earned interest rose 49% over that same period.

“Does it make sense to have the money in a noninterest account? It used to,” said Tom Hunt, director of treasury services at the Association for Financial Professionals. When the trade group surveyed its members who work in corporate finance, it found companies in 2018 kept less of their short-term cash in bank deposits and more in higher-paying investments.

The result: Not only do the banks have to pay up for more of their deposits, they also have to pay more on the deposits that pay interest. Both factors weigh on bank lending profit margins, which are closely watched by investors.

“Non-interest-bearing deposits are the goose that lays the golden egg for a bank,” said Gerard Cassidy, an analyst at RBC Capital Markets. Their decline, he added, is one reason the profit boost from rising interest rates will likely end over the next year or so.

Related video: A brief history of retail banking

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