Community Bank Deposits: Where Have They Gone?

This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, appears at least once each month.

Banks—especially small banks—have traditionally made money by accepting deposits from local customers and then lending the money at a higher rate. The difference—called the net interest margin—was and is used to:

• Cover overhead, other expenses and provisions for loan losses
• Pay taxes
• Reward investors with dividends

That model worked pretty well for decades. However, growing competitive and technological changes are altering the banking landscape. And the changing behavior of “core” depositors is affecting small-bank balance sheets.

Core Challenges

So what is happening and why? Community bankers surveyed by state bank commissioners as part of the 2019 Community Banking in the 21st Century research and policy conference cited several factors for the challenge of both holding onto core deposits and keeping their costs down."Community Banking in the 21^st Century (PDF)." Federal Reserve System, the Conference of State Bank Supervisors and the Federal Deposit Insurance Corp., Oct. 1-2, 2019.

Most noted market competition, particularly from other depository institutions that had local headquarters or branches. Others pointed to internet competition, including competition from banks elsewhere in the country. Still others cited nonbank financial competitors, including the prevalence of apps that provide banking-like services. Deposits generated through those apps are held in banks, but they may be far away from the app user’s location. As one survey respondent put it, “Apps remove the need for bank products other than as holding tanks for short-term cash deposits.”

The funding challenges facing traditional banks are not limited to growing competition. Shrinking rural markets also make it difficult to attract and retain traditional core deposits. Many rural areas are facing an out-migration of population, reducing the local deposit base. And some bankers reported that younger consumers—in addition to being more comfortable with new technologies—are not saving as much or in the same way as their parents and grandparents.

New Funding Sources, New Risks

The change in deposit competition means new risks for many small banks. Interest rate risk tops the concerns, as deposits generated through nontraditional means are typically more sensitive to changes in interest rates, particularly rising rates.

Bankers also face more uncertainty with regard to deposit longevity. Deposits may not “stick” with a bank if the depositor finds a better deal elsewhere. For that reason, banks must more carefully plan to meet unexpected deposit runoff. This is especially important should a bank experience financial difficulties.

What about the Future?

Banks—as well as bank regulators—are adapting to the new funding environment but are concerned about the unintended consequences should these challenges grow. This includes a possible acceleration of industry consolidation. In the meantime, the consumer holds the key!

Notes and References

¹ "Community Banking in the 21^st Century (PDF)." Federal Reserve System, the Conference of State Bank Supervisors and the Federal Deposit Insurance Corp., Oct. 1-2, 2019.

Additional Resources

• Community Banking in the 21st Century conference
• On the Economy: Fintech: How Technology Is Changing Consumer and Small Business Lending
• On the Economy: Banking on “Bank On”