What to Do With the Deposit Influx Wave

This was reprinted with permission from SRM’s blog.

We are now living through a highly unusual economic scenario.

Dubbed a K-shaped recovery by some, a severe economic downturn has arrived hand-in-hand with a sudden and significant inflow of consumer deposits.

The reasons behind this phenomenon are debatable. The broad-brush U.S. approach to government stimulus/relief certainly plays a role, but no bank or credit union leaders saw this coming as Paycheck Protection Program funding scenarios began to unfold. The result is a bizarre banking dynamic that’s a far cry from the challenges of recent years. Gone are the days of fighting to grow deposits by more than low single digits per annum. In 2020, it was not unusual for institutions to have registered checking balance growth of 15-25%. One client we’re aware of saw deposits grow unexpectedly by $1 billion.

From a bank or credit union’s perspective, a historic, pandemic-grade deposit influx may be the proverbial good problem to have, but it’s a problem nonetheless.

Deposits can represent a financial institution’s lifeblood, a necessary foundation to enable lending into the community. But what can credit unions reasonably do with a surplus of it, especially in a down economy?

Putting the Money to Work

The loan-to-deposit ratio is a key metric at many a banker’s annual board meeting. Over-lending creates liquidity risk and the potential inability to meet short-term obligations. Under-lending, however, creates a drag on earnings since interest paid on outstanding loans is a primary revenue source.

Before 2020, the challenge was to attract sufficient deposits to support loan demand. Virtually overnight, the opposite became true—deposits are plentiful, but loan demand relatively weak.

The pandemic has also heightened repayment risk for many existing and new loans. Interest rates are also near zero, leaving financial institutions few good investment alternatives for surplus funds and the challenge of finding productive, profitable uses for these new deposits.

The Tide Comes In; the Tide Goes Out

A new question in this unusual economic climate has arisen: “Can financial institutions count on this abundance of deposits in the long run?” With more government stimulus checks on the horizon, deposits could easily swell further. They could quickly vanish, as well.

Hot money (time deposits like certificates attracted by high-yield promotions) can be at greater risk of departure at maturity in the coming months. What’s more, even short-term expiration dates don’t protect savings and checking account deposits from a sudden outflux.

In these conditions, leaders now face generating new loan demand and instating protective measures in case of a sudden run on deposits.

The Bottom Line

FIs with an excess of deposits must strike a delicate balance between generating prudent loan demand and ensuring adequate liquidity—especially if these new balances prove overabundant or temporary.

To date, credit unions have weathered the current economic storm nicely, earning kudos for supporting consumers and small-business customers on multiple fronts. The unexpected inflow of deposits is a welcome vote of confidence, but several financial management challenges come with it.

Ben Mrva is EVP of CUESolutions Bronze provider SRM, Memphis. For more about recalibrating for COVID-19, read Long-Term Planning in Short-Term Uncertainty by Larry Pruss.