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US banks braced for large deposit outflows

US banks are steeling themselves for the possibility of losing as much as $1tn in deposits as the Federal Reserve reverses its emergency economic policies and raises interest rates.

JPMorgan Chase, the biggest US bank by deposits, has estimated that money funds may withdraw $100bn in deposits in the second half of next year as the Fed uses a new tool to help wind down its asset purchase programme and normalise rates.

Other banks including Citigroup, Bank of New York Mellon and PNC Financial Services have also said they are trying to gauge the potential effect of the Fed's exit on institutional or retail depositors who might choose to switch to higher interest accounts or investments.

Mladen Antonov | AFP | Getty Images

"There are investors, traders and sellside analysts that are very concerned about it," said one top-10 investor in several large US banks.

An outflow of deposits would be a reversal of a five-year trend that has seen significant amounts of extra cash poured into banks thanks to the Fed flooding the financial system with liquidity. These deposits, which act as a cheaper source of funding, have helped banks weather the aftermath of the financial crisis.

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Now the worry is that such deposit funding may prove fleeting as the Fed retreats. Banks might have to pay higher rates on deposits to retain customers – potentially hitting their profits and sparking a price war for client funds.

SNL Financial estimates that US banks have collectively increased their deposits by 23 per cent over the past four years, at the same time that their cost of deposit funding has dropped to a 10-year low.

"You essentially have frictionless non-interest bearing deposits funding much of the banking system today," said Peter Atwater, former JPMorgan banker and president of research firm Financial Insyghts. "There's no financial incentive to stay."

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Banks also face the retreat of large institutional deposits as the Fed uses a new tool known as a "reverse repo facility," or RRP, to stage its retreat. The RRP effectively allows non-banks such as money funds to have reserve accounts at the Fed.

"It would drain reserves from banks," said Guy Moszkowski, analyst at Autonomous Research.

Potentially offsetting any outflows are new regulations that reward banks for accumulating what the rules deem to be more stable, or "sticky", deposits – such as retail deposits that are insured by the US government.

At least one big bank says it has been actively encouraging money funds to take advantage of the RRP as a way for them to move less sticky deposits to the Fed and leave more stable ones with the bank.

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"There are quite a lot of excess deposits in the system," said Christopher Wolfe, analyst at Fitch Ratings, which recently warned on potential bank deposit outflows.

He added: "Some of that's going to find a new home in a different rate environment. Depending on how that plays out, if rates gradually move up in a benign scenario, we don't think that's an issue. If you had a sudden shift in the rate environment, you could see that play out differently."

JPMorgan's $100bn in projected outflows is roughly 7.8 per cent of its deposit base as of the first quarter, according to SNL Financial.

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Second-quarter deposit data are not yet available, but analysts say that would equate to about $880bn to $1tn worth of outflows from the entire industry.

—By Tracy Alloway and Camilla Hall, The Financial Times

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