Evening Brief – 04.26.23

First Republic’s slow demise should be a stark reminder that all is not well in the banking sector. The Fed wants to believe it was a few bankers with concentrated business models in tech startups and crypto. They argue the crisis is over now that the FDIC has taken over some banks. If this is the right explanation, then tight monetary policy is not a contributor, and the Fed can keep hiking rates to deal with inflation.

Many investors want to believe it was a temporary panic because SVB failed and large depositors, over the FDIC guarantee limit of $250,000, ran for the safety of “too-big-too-fail” banks. For them, the problem was not rates at too high a level but the speed at which they moved. So, the Fed needs to pause.

Some investors believe the problem may be getting worse. In the modern technology era of moving money, near-0% deposit rates must now compete with market rates around 4.50%. Depositors who had been gettingclose to 0% have been leaving banks in accelerating amounts since November.

The problem of a huge incentive to move out of low-yielding bank accounts still exists. The incentive will increase after the Fed hikes again in May (5%-plus money market funds are likely). This behavior is completely rational. It is irrational to argue that depositors will forego five minutes on their banking app to gain many an interest rate advantage because they value the safety of a “too-big-too-fail” bank at near-0% in a 5% world.

Interest rate hikes accelerate the deposit flight and worsen the situation. Banks lose their deposits and then start pulling back on lending, leading to a credit crunch.