NEW YORK–A new report suggests recent bank failures are upending a long-held theory among banking executives and regulators—"that the value of a lender’s deposit business goes up when interest rates move higher.”
As the Wall Street Journal noted, the theory rests on an assumption that banks don’t have to pay depositors much to keep their money around, even as rates rise. The deposits would be a stable source of low-cost funding while the bank earned more money lending at higher rates, the report added.
The SVB Example
“The more rates rose, the bigger the franchise value of those deposits would become—a natural hedge against the declining market values of a portfolio of fixed-rate loans and bonds,” the Journal’s analysis continued. “But if rising rates or plunging asset values cause a bank’s depositors to flee en masse, the franchise value is zero—and, worse, it could beget other bank runs,” as happened at Silicon Valley Bank.
“The current environment of declining deposits and runs on banks raises questions about whether most deposit amounts are sustainable, especially uninsured deposits, reducing deposit-franchise value,” Tom Linsmeier, an accounting professor at the University of Wisconsin and a former Financial Accounting Standards Board member, told the Journal.
As the report further explained, the franchise value of deposits doesn’t appear on banks’ financial statements.
Complex Models
“Banks use complex models to estimate the value, and they include it in an alternative measure of net worth called ‘economic value of equity’ that lenders and regulators cite frequently,” the Journal reported. “That number is often higher than a bank’s total equity, or assets minus liabilities, due to the franchise value of deposits.”
The Federal Reserve, which both regulates banks and sets interest-rate policy, in a November report pointed to large unrealized losses on banks’ bond holdings due to rising rates, the Journal stated.
“Things weren’t so bad, the Fed said, because ‘the value of banks’ deposit franchise increases and provides a buffer against these unrealized losses’,” the Journal report added.
‘Weaknesses in Regulation’
But as the decline in assets’ market value contributed to the run at Silicon Valley Bank, the Fed has since stated “SVB’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed.”
Feeling the FOMO Fever? CUToday.info Has a Prescription
Are you missing out on the latest news in credit unions? Missing the trends and developments you need to be aware of? We can help. Each morning CUToday.info delivers its daily Fresh Today news update offering the latest headlines and breaking news right to your email, with the easy-to-read headlines format allowing you to click on the stories that interest you most in order to learn more.
And it’s free!
If you haven’t yet signed up for the new email solution on which CUToday.info has partnered with ResponseGenius, you can do so here. Signing up requires less than one minute of your time—and it’s free!
Please note that after signing up you may need to go to your Spam/Junk folder and mark the morning headlines email as safe. CUToday.info does not provide its list of readers and emails to outside parties, and we will not be contacting you to sell you an extended warranty or sending you any links so you may cash in on an inheritance you didn’t know was coming.
And did we mention it’s free?
Please note and/or make your IT department or email administrator aware the emails will be coming from the domains CUTodayinfo.com and CUTodayinfoReply.com.