As interest rates rise, inflation remains stubbornly high, and markets go sideways, we dig into the FFIEC’s recently released Q2 call report data to understand how the banking sector is reacting.
Since the Fed first raised rates at the end of Q1, there has been a significant draining of liquidity from the sector. Between Q1 and Q2, deposits dropped by $365B — roughly 2%. Deposit decreases are infrequent; in the 90 quarters since 2000, only 11 quarters have seen a decline in deposits.
The fall in deposits was driven by core deposits; core funds decreased by $397B over the past quarter. This was partially offset by wholesale funding; wholesale funds increased by $178B. As we wrote about several months ago, core deposits tend to decrease as rates rise because other asset classes, such as Treasurys, begin to look more attractive. Banks typically tap wholesale funding to maintain their balance sheets.
The amount of liquidity in the system may affect monetary policy. Reserves held at the Fed decreased by $699B last quarter as the central bank began unwinding its balance sheet [1]. As we previously mentioned, the Fed intends to maintain “ample” reserves in the system. If reserves threaten to become scarce, the Fed may slow or stop quantitative tightening, as they were forced to in 2019 [2].
A confluence of monetary and market forces has resulted in a dynamic environment. We’ll be closely watching the data moving forward.