Cybersecurity, Risk and Regulatory
Navigate risk, regulatory compliance, and cybersecurity with confidence and protect your data with PwC’s cyber risk and regulatory consulting services.
In the days following these recent events, many are publicly questioning what can cause a bank to be liquidated, voluntarily or by the government. At first glance, these could appear to be isolated incidents associated with banks concentrated in particular industries. However, they actually illustrate the importance of effective bank balance sheets, liquidity and interest rate risk management practices during challenging and uncertain economic conditions.
The first two years of the pandemic saw record increases in deposit portfolios as individuals and companies significantly curtailed spending, increased savings and received government support. Many banks looking for ways to increase interest income invested these deposits in investment securities, particularly because reduced individual and corporate spending translated into limited loan demand. The investment securities commonly selected were high-quality, government-secured debt instruments that do not require risk-based capital reserves and can be used to generate liquidity in a stress event. However, investment securities are highly sensitive to changes in interest rates.
Since early 2022, the Federal Reserve (Fed) has raised its benchmark interest rate by more than 4.5%, which significantly reduced the value of these investment securities and produced “unrealized losses” on bank balance sheets. These interest rate increases have also driven bank customers to shift bank deposits to other products like money market funds in search of higher yields. This dynamic as well as customers’ increased spending of cash accumulated during the pandemic has culminated in a loss of funding for many banks.
This combination of reduced values in investment portfolios and increased pressures from deposit outflows has led to challenges in managing liquidity risk, particularly as selling lower-yielding investment securities at a loss to cover deposit outflows erodes capital. The liquidity risk is heightened when the deposit base of an institution is comprised of larger, shorter-term, interest rate sensitive deposits. The balance sheet mismatch between long duration bonds such as US Treasuries and Agency Mortgage Backed Securities versus unstable deposits displays a classic problem in bank risk management known as the asset-liability mismatch. Banks commonly measure these mismatches and set limits to control the risk, but these limits are not always effectively managed because hedging or forgoing interest income could hurt bank profitability.
Fast forward to 2023, deposit outflows have been cited as a growing concern across the industry with the Fed considering further rate increases. These recent events demonstrate the potentially critical impact of increased deposit outflows surpassing existing liquidity buffers held in the form of cash and highly liquid securities that decline in value and highlight the need for all banks to continuously evaluate and adapt their liquidity risk and interest rate risk management practices.
This week’s banking announcements highlight the importance of effectively managing the risks inherent in this environment. A number of uncertainties remain, including future Fed interest rate decisions and how current market dynamics will impact bank balance sheets going forward. Banks should bring together decision makers across Product, Pricing, Marketing, Communications, Finance and Risk to consider the following:
Banks that have strong balance sheets with liquid securities, diversified deposits, multiple contingent funding sources and robust asset liability management practices may see opportunities to acquire new customers, portfolios or entire banks. They should consider the following to assess their readiness for deals or rapid client onboarding:
The impacts from the recent market events, both on the banking industry and the broader economy, continue to evolve; accordingly, we are closely watching the following areas:
The current environment presents notable risks but also significant opportunities for banks with highly liquid balance sheets and thoughtful growth strategies. Firms should be considering the key levers around deposits, balance sheet management and deal-making, but also evaluate overall profitability levers including client strategy, product mix and cost. Short of an outright transaction, some banks may experience growth as customers potentially shift deposit relationships. Firms should be prepared for understanding how customer growth aligns to strategy and impacts balance sheet risk. While uncertainty remains high, we are confident that complacency will not be a winning strategy.
Navigate risk, regulatory compliance, and cybersecurity with confidence and protect your data with PwC’s cyber risk and regulatory consulting services.
Change remains a constant in financial services regulation. Read our take on the latest developments and what they mean.
Risk executives invest to meet higher standards of resilience in a multi-crisis world and to better manage inherent risks in a digital society.
Learn more about PwC's banking and capital markets practice which serves all financial industry segments.