Rising Risk: US Banks Face Deposit Flight Threat With Shrinking Profits

Moody's, the credit ratings agency, recently issued a new cautionary message concerning the U.S. banking system.

What Happened: Moody's shared in a note its decision to lower the ratings of 10 regional banks and that it is contemplating whether to downgrade several major lenders, including Bank of New York Mellon Corp BK, U.S. Bancorp USB, State Street Corp STT, Truist Financial Corp TFC, Cullen/Frost Bankers, Inc CFR and Northern Trust Corp NTRS.

The agency warned that American banks are now faced with the possibility of increased deposit outflows due to declining profitability and the Federal Reserve's ongoing rate hikes.

"U.S. banks continue to contend with interest rate and asset-liability management (ALM) risks with implications for liquidity and capital, as the wind-down of unconventional monetary policy drains systemwide deposits and higher interest rates depress the value of fixed-rate assets," it said in its note.

"Although the general drain on deposit funding caused by quantitative tightening (Q.T.) moderated in Q2, there remains a significant risk that systemwide deposits will resume declining in coming quarters," it added.

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The note further pointed out that "[most] banks' deposits were flat or down only modestly, but the mix worsened, with non-interest-bearing deposits declining and banks paying more for deposits."

"The resulting drop in net interest income and net interest margins eroded profitability and, thus, the ability to replenish capital internally," Moody's explained. 

The credit rating agency said it anticipates that the Federal Reserve will maintain higher interest rates until inflation aligns with its target of 2%. Additionally, Moody's suggested that, if the economy were to experience a recession, lending losses for U.S. banks could significantly rise.

"[Many] banks' Q2 results showed growing profitability pressures that will reduce their ability to generate internal capital. This comes as a mild U.S. recession is on the horizon for early 2024 and asset quality looks set to decline from solid but unsustainable levels, with particular risks in some banks' commercial real estate (CRE) portfolios," the agency said.

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