Abstract: Whether maturity transformation exposes banks to interest rate risk depends in part on the effectiveness of bank deposits as a hedge against interest rate shocks. In this paper, we provide evidence that, despite an increase in the average maturity of bank assets, the duration of bank equity was negative for most of the post-financial crisis era. We document that an important factor contributing this was an increase in the average duration of deposits due to a positive relation between deposit betas and the level of interest rates. The dynamic nature of the duration of deposits also explains why deposits provided a poor hedge against recent rate hikes. Overall, we find that variable deposit betas contribute to the negative convexity of bank equity.
Discussant: Sergey Sarkisyan, Ohio State University
Abstract: We argue that heightened regulation on large banks contributed to the rise in fragility of smaller banks revealed by the 2023 regional bank crisis. In 2018, U.S. regulators restricted Wells Fargo from growing beyond $1.95 trillion in assets. Wells Fargo gave up large uninsured deposits to stay under the asset cap. We find that smaller and less regulated banks stepped in to fill the gap. Banks more geographically proximate to Wells Fargo experienced an influx of flighty uninsured deposits, particularly during the COVID-19 period. In turn, these banks experienced higher deposit outflows once monetary tightening commenced, and had lower equity returns following the collapse of Silicon Valley Bank. Additional analyses show that the deposit reallocation is not driven by local demand or general proximity to large banks.
Abstract: Deposits are an important source of capital in the economy and the main form of bank financing. However, unlike other liabilities, not all deposit flows stem from a bank actively seeking them. In this paper, we show that banks that experience these inflows increase risk due to heightened leverage uncertainty and greater concerns about costly equity issuance. When the Fed funds rate rises, they face bigger losses and deposit outflows. This mechanism also plays a key role in understanding the 2022–2023 U.S. bank fragility episode, as the risk exposures of banks were amplified following deposit inflows in 2020–2021.
Discussant: Hélyoth Hessou, Université de Sherbrooke
