The US midsize banking sector has come under strain due to a surge in higher-interest borrowing from the Federal Reserve, the Federal Home Loan Bank system, and brokered deposits from little-known intermediaries. These borrowings were used to counterbalance customer withdrawals and amounted to a 12-fold increase in interest expenses to $72 billion in the first quarter of 2023, threatening the profitability of several regional banks. A drastic increase in brokered deposits— referred to as "hot money" due to their lack of permanence— has led to a whopping $1.42 trillion in borrowing for the 84 largest banks that control over 80% of the industry's assets.
Concerns for bank shareholders mount as the first quarter's higher costs potentially signal the beginning of further financial strain. Various regional banks such as Silicon Valley Bank and Signature Bank were severely affected by the Federal Reserve's aggressive interest rate hikes. This increase in funding costs and the fall of profits could lead to losses that will impact capital, causing investors and regulators to lose patience. Moreover, the issue may be amplified as a complete financial quarter has yet to be observed under these new conditions.
Banks have begun to experience a significant rise in brokered deposits, typically made up of certificates of deposit that hold the promise of higher rates. Banks have found themselves obligated to pay these higher rates over an extended period, which could prove burdensome in the long run. Shareholders have noticed this trend, leading to a slump in stock prices for firms like PacWest Bancorp and Western Alliance, where brokered deposits have soared. These developments have resulted in analysts' skepticism about the prospects of these banks.
Despite the increase in net income in the first quarter of 2023, the banking industry is bracing for challenging times ahead. Rising funding costs and threats of decreasing profitability have alarmed shareholders. Some banks like M&T Bank Corp. and Fifth Third Bancorp have warned about future profitability constraints. Additionally, First Republic bank's failure highlighted the potential instability of replacing core deposits with higher-interest borrowings and hot money, which could lead to unsafe or unsound business practices.
