Dial into any bank earnings call these days and you will hear lots of talk about “deposit beta.” The phrase came up 29 times in the presentations following results from four of the largest US banks last week. A metric that analysts have tracked for years has hit the mainstream.
What is deposit beta? Technically, it’s a measure of the pass-through of monetary policy to savers: The portion of the change in the central bank rate that a financial institution passes on to customers via higher deposit rates. But it's also a measure of pricing power: the lower the deposit beta, the better for bank shareholders; the higher, the better for customers.
Deposit beta typically starts low and edges up as rates rise. Depositors tend not to be that sensitive to the first 50 basis points of hikes, and banks can keep most of the benefit to themselves. As rates continue to move up, more of the increase gets shared with customers. “Deposits have beta and gamma,” JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon explained to shareholders back in 2015, referring to an options term that conveys a non-linear relationship.
In that last tightening cycle, between 2016 and 2019, banks ended up passing on close to 40% of Fed rate increases, according to data from the Federal Reserve Bank of New York. Going into the current cycle, analysts anticipated a similar, maybe slightly lower outcome, given how flush banks were with deposits.
Yet few expected as rapid nor as pronounced a shift up in rates as we’re seeing now, a mix that has affected depositor behavior in ways banks struggled to model.
Last week, State Street Corp revealed that it is now passing on 100% of recent rate hikes, taking its cumulative deposit beta to over 70% in the current cycle. Chief Financial Officer Eric Aboaf warned that the pass-through is only going up. “We are going to have a quarter where betas are well above that 100% level,” he said.
It’s a big change from a year ago when Aboaf projected sequential quarter betas in the 60% range after the first four or five rate hikes. “Rates are much, much higher, [moved] much more quickly and much more visibly,” he now says. His sophisticated institutional clients “have real substitute alternatives that they used to not have in the past, whether it's treasuries, whether it's money market, whether it's a repo, there's a range of what they can invest in.”
As a result, State Street was forced to pay an average rate of 3.48% on interest-bearing deposits in the three months ended June 30, up from 0.02% in the first quarter of 2022. It has additionally faced outflows of non-interest-bearing deposits – a bank’s cheapest source of funding – which are down 41% from their level before tightening began in the first quarter of 2022.
Other banks will be looking on with concern since any trend that starts with sophisticated customers is likely to fan out. Among households, the more affluent are already draining their deposits. Deposits in Wells Fargo’s wealth management segment are down 41% since March 2022 and at JPMorgan, they are down 30%.
For now, those banks are not in a position where they need to pay up to keep depositors. The cumulative deposit beta at Wells Fargo & Co. is 33% and at JPMorgan, it is 45%. In contrast to State Street, JPMorgan is currently seeing slower deposit repricing than previously assumed, allowing it to raise guidance for net interest income for the current financial year.
But those good times will end. “I think it's safe to say there is very little pricing power in most of our business, and betas are going to go up,” Dimon told investors on his earnings call. “You take it as a given.” As a result, JPMorgan expects that net interest income will normalize from a high of $87 billion in the current financial year to the mid $70 billion in the medium term.
As other banks host earnings calls through the rest of this week, deposit beta will likely emerge as a key talking point. Banks exhibit a range of different business mixes and funding needs, but none has managed an interest rate cycle quite like this one.
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