Coronavirus deposit bonanza can spell trouble for banks

At the largest U.S. banks, deposits grew at historically unprecedented rates in the first quarter of 2020. JPMorgan Chase and Citigroup each saw increases exceeding 20 percent, while at Bank of America, the deposit growth topped 15 percent.

JPMorgan Chase said that commercial clients have been drawing down on credit lines to hold onto liquidity. Bank of America noted that consumer and wealth management clients drove deposits higher as they fled equity markets. Regional banks also experienced deposit growth although not to such a degree as the three big banks. One thing is clear: everybody is looking to hold onto cash.

How long these deposits will stick around is anyone’s guess.

Some of these deposit balances will flow out over time as bank clients pay bills, cover costs and pay employees. Nonetheless, even after factoring for all that, as Bank of America’s CFO Paul Donofrio noted in the bank’s quarterly analyst conference call, “there is a lot of uncertainty.”

How should banks respond to this sudden deposit bonanza and to what extent is this problematic?

Start scenario building 

Banks can start with a straightforward exercise of mapping money movement trends between various deposit, investing and lending accounts. This flow-of-funds exercise, which analyzes the internal movement of funds between a pair of products owned by the same customer or household and externally involving accounts held with other financial institutions, can give a bank a clearer view of evolving bank customer behaviors.

For example, a focused flow-of-funds analysis might reveal spikes in client funds moving from investments products within the bank to seek the safety of cash. It might also detect a reverse pattern start to take form as consumers regain confidence in the post-pandemic world.

Scenario narratives supported by this type of data can help banks accurately predict the different pathways deposit flow and balances are likely to take in the coming months, and inform bank executives of the appropriate response.

It is also critical that banks distinguish between deposits that are likely to stay and on-the-move deposits that will get reinvested back into investment instruments, pay bills or to pay down credit lines. After factoring for the COVID-19 stimulus, a bank might uncover they need to be more aggressive with deposits acquisitions. Alternatively, a bank might find their deposits balances are too high even after accounting for the coronavirus effect. This would require a different strategy altogether.

Comparing historic data on customers’ fund transfers, savings patterns, demand for loan, and other behaviors in pre-pandemic versus pandemic times can reveal invaluable insights. These observations can be used to develop more targeted and precise deposit acquisition, retention or alternative strategies to meet organizational goals.

Too much of a good thing 

Excessive deposits can be a problem. The flood of cash into banks can create an imbalance in a bank’s deposit-to-loan ratio, putting pressure on banks to lend. Credit risk and the potential that a given borrower will not meet its obligations is particularly high given the current adverse economic environment. Businesses are likely to fail or take several years to recover even when the pandemic is behind us.

Banks do not have an unlimited appetite for risk, but high deposit balances might invite criticism from politicians and interest groups pressuring banks to explain why they are not lending to support the economy.

There is an opportunity for banks to improve lending practices, especially to small and medium sized enterprises (SME). According to a 2020 Consumer Financial Protection Bureau study, small-business lending between 2010 and 2017 has yet to return to the levels before the 2008 recession.

Banks can step up their SME lending by incorporating innovative approaches and new technologies, or by partnering with fintech firms to address common credit risk assessment challenges such as difficulty predicting future cash flows, loan management and business model sustainability.

Banks can also introduce ecosystem logic to SME banking relationships. By shifting from a point-of-service model to an ecosystem-centric approach, banks can become integral to the operational financial processes among their SME customers’ suppliers, customers and distributors. An example would be that when lending to a life science company, a bank would lend in a manner aligned with key companies in its supply chain to ensure ongoing delivery of needed raw and finished materials.

The ability to analyze customers’ spending, savings, investing, borrowing and other banking patterns for relevant insights is a critical determinant on how effectively banks can respond to changing market conditions and evolving banking behaviors. This is especially true as the coronavirus pandemic reshapes the retail banking landscape in ways yet to be determined.

Wei Ke, Ph.D. is a managing partner at global consulting firm Simon-Kucher & Partners. Simon-Kucher senior advisors Leo D’Acierno, Betty Cowell and Rick Spear also contributed to this article.