U.S. Bank Liquidity, Credit Ample As Fed Delays Taper

The announcement by the Federal Reserve that it will make no changes in its asset purchase program suggests that U.S. bank liquidity will remain near record levels, as securities held on the Fed's balance sheet continue to grow. When a tapering of QE does eventually begin, Fitch expects the impact of reduced bond buying to have little immediate effect on banks' lending capacity and funding costs.

Five years after the start of quantitative easing by the Fed, sustained asset purchases and slow loan growth have created a large deposit cushion for banks that should begin to fall only slowly when monetary stimulus is unwound.

Excess deposits (deposits minus loans) in the U.S. banking system remain at an all-time high. September Fed data indicate that they totaled $2.24 trillion (approximately 14% of GDP). Total bank cash holdings were $2.44 trillion. By comparison, the cash balances figure in September 2008 (before the launch of QE) was $388 billion.

The gradual start of a wind-down in Fed bond purchases will eventually begin a process in which banks' cash holdings and loan-to-deposit ratios return to historical norms. A steady reduction in the money supply will lead to a manageable run-off in excess deposits.

While lending capacity will not be eroded by future tapering, borrowers are already feeling the effects of higher interest rates brought about by anticipation of the Fed's asset purchase pull-back. This has been evident since early summer in the mortgage market as refinancing activity has slowed.

As a result of robust liquidity positions and excess deposits, no near-term changes in banks' funding costs are likely once tapering begins. Deposit pricing will remain inelastic. However, to the extent that tighter monetary policy ultimately drives short-term rates higher, some banks with higher loan-to-deposit ratios could begin to see cost pressures in funding.

For a detailed analysis of U.S. banks' liquidity and deposit profiles, as well as a review of QE-driven excess-deposit growth, see the special report "U.S. Banks: Liquidity and Deposit Funding," dated Aug. 8, 2013, at www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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