Bank Deposits: Understanding the Factors Behind Decreases and the Impact on the Financial System

What Are Bank Deposits

Bank deposits are liabilities of commercial banks. They can only be reduced if a corresponding bank asset—such as a loan, currency held at the bank, or that bank’s reserve account at its own bank, the Federal Reserve (Fed)—is reduced by the same amount.

Bank deposits fall when customers pay back loans or exchange deposits for cash, a bank sells an asset to a nonbank entity, or the Federal Reserve stops reinvesting mortgage payments during quantitative tightening (QT).

Are Any of These Activities Concerning?

Since the collapse of Silicon Valley Bank (SVB), there has been much talk about bank deposits leaving the banking system. Is that possible? Even if money is withdrawn, doesn’t it have to be deposited into another bank account eventually? 

Of course, when someone pays back a loan to a bank (loans are bank assets) or the Fed doesn’t reinvest mortgage payments, that reduces total deposits. The same occurs when a bank sells an asset, such as a government bond, to a nonbank. However, in these situations, deposits aren’t leaving: They are being extinguished with an offsetting reduction in bank liabilities.

Transferring your bank deposit to a nonbank entity, such as a money market mutual fund, will also not reduce the number of bank deposits or bank reserves in the banking system.

Overview of Silicon Valley Bank (SVB)

Silicon Valley Bank (SVB) was an odd bank. Most of its deposits (around 90%) were larger than the $250,000. When customers learned that SVB’s assets—in this case, government bonds and mortgage-backed securities (MBSes)—were less than their total bank deposits, people and companies with uninsured balances began moving them to other banks or financial institutions.

The SVB model had two flaws. First, most of its deposits were uninsured. Second, instead of leaving its reserves at its own bank, the Fed (where SVB would have earned a bond-like return with no principal risk), SVB bought Treasury bonds and mortgage-backed securities that fell in value in 2022 when interest rates rose. Uninsured depositors who got wind of this moved their deposits en masse, leading to an old-fashioned bank run.

Since then, there has been a daily barrage of articles and tweets about bank deposits leaving the banking system, scaring people into believing that we are about to experience a repeat of the 2008 financial crisis or, even worse, the bank runs of the late 1920s. Unfortunately, these authors and tweeters are unaware that bank deposits cannot leave the banking system.

Loan Payback

Paying back a loan reduces bank deposits because the payer of the loan has their bank deposit, a liability of the bank, reduced by the amount of the payment. However, that payment also reduces the loan balance, which is an asset of the bank. Because no one deposits the payment back into the banking system, loans always reduce bank deposits. In contrast, new loans increase bank deposits.

Exchanging Bank Deposits for Cash

Another way to reduce bank deposits is when a customer of a bank exchanges a deposit account for cash. For example, when you go to your bank and write out a check for cash, you are telling the bank to reduce your deposit account by that amount and distribute it to you in currency.

Here, the bank reduces cash on hand (an asset) and also reduces a liability for the amount withdrawn from your deposit account. As a result, the money withdrawn as cash is no longer a bank liability. However, it becomes a liability to the US government.

When a Bank Sells an Asset 

Since the fall of Silicon Valley Bank, there has been a notable reduction in bank deposits. Many opine that money is leaving the banking system and heading to mutual fund money markets, implying that people are becoming afraid of the banking system. 

Transferring your bank deposit to a nonbank entity, such as a money market mutual fund, will not reduce the number of bank deposits or bank reserves in the banking system. This is because your bank account (a liability for your bank) gets reduced, but at the same time, your bank’s assets (reserves at the Fed) also get reduced. At the same time, the bank for the money market receives a new deposit (a new liability for that bank) offset with new reserves (an asset) transferred from your bank’s reserve account at the Fed to the money market’s bank reserve account. The number of deposits and reserves stays the same; it’s just that different banks hold them.

What is more likely happening right now is that some banks that had business models like SVB’s are selling some of their treasury or MBS holdings to get bank reserves to shore up their ability to handle possible withdrawals.

If these banks sell these assets to nonbanks, such as mutual fund pension plans, the bank account of the entity buying them gets reduced by the cost of purchasing them. The bank selling the asset gets bank reserves from the buyer’s bank. Again, systemwide bank deposits fall because the buyer’s bank account falls. However, simultaneously, the seller’s bank receives reserves held at the Fed and not a new deposit at a bank. So here, the banking system’s assets remain the same, unlike paying back a loan. It is just that deposits are exchanged for reserves.

How Quantitative Tightening Reduces Bank Deposits

After its balance sheet ballooned to almost eight trillion dollars, the Federal Reserve started reducing it in June 2022 by allowing treasury bills and bonds to roll off when they matured. The Fed also stopped reinvesting people’s mortgage payments into new mortgage-backed securities.

Of these two actions, only the reduction in mortgage-backed securities totals reduces bank deposits because, just like any other loan payment to a bank, a decrease in bank deposits results. Here, customers have their checking accounts reduced by the payment amounts. The Fed, which owns MBSes, reduces its value by the payment amount. This is no different from what would happen if a commercial bank and not the Fed owned the MBS.

Conclusion

As you can see, bank deposits go down all the time in the natural course of running an economy. Banks often offset any reductions by creating new bank deposits when making new loans. Even when bank deposits go down, this doesn’t represent them leaving the banking system overall; they are just being extinguished with offsetting reductions in bank liabilities, which is part of the normal operation of a bank.

These are the opinions of Financial Advisor Tim Hayes and not necessarily  those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice.