Fitch Ratings published two articles recently of interest to the money markets. The first, entitled "Shock Scenarios: U.S. Bank Deposits," says that "a rise in retail bank deposit rates would dampen bank profitability" and that "high online bank rates could pressure traditional banks." The second release, entitled, "European MMF Reform Won't Affect Corporate Cash Analysis," tells us that European money market funds should still be "cash" under pending regulatory changes. We excerpt from both updates below.
Fitch's first paper tells us that "The interest on deposits offered by commercial banks in the U.S. remains at historically low levels, despite recent Fed Funds rate increases. In 3Q17, U.S. depository institutions offered 7bps in interest on retail savings deposits and money market deposit accounts (MMDAs) of less than $100,000 on average compared to 118bps on savings accounts and MMDAs at U.S. online banks, according to Federal Deposit Insurance Corporation (FDIC) disclosures."
It continues, "Fitch has conducted two hypothetical scenarios on depository institutions that envision immediate increases in rates paid on retail savings deposits and MMDAs solely as a result of pressure from online bank competition. These scenarios assume no change in the general level of market rates and, therefore, do not affect asset yields. The shock scenarios considered in the report differ greatly from Fitch Ratings' current base and stress case expectations and are not intended to question the assumptions underpinning Fitch's existing credit ratings or outlooks."
This could lead to "Mounting Pressures for Banks," they say, explaining, "The gap between the simple average retail savings deposit rate offered by U.S. commercial banks and the weighted average rate offered by online banks has widened since the Federal Reserve began raising the Fed Funds rate in December 2015. The difference was 111bps as of 3Q17, up from 77bps at the time of the first Fed Funds rate increase in 4Q15.... Fitch does not currently expect large commercial banks in the U.S. to be pressured to match the retail deposit rate offered by online banks <b:>`_. However, Fitch anticipates some increase in deposit costs in the near- to intermediate term for these banks independent of the scenarios outlined below."
The paper states, "Retail deposits are an important source of funding for banks, given their favorable regulatory treatment, historically low cost relative to other funding sources and stability under most situations. Post-crisis regulations from Basel III, such as the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR), provide additional incentives for banks to finance their operations through these deposits by treating them as the most stable source of funding. Should online banks pose a threat to either the cost or stability of these deposit balances, large commercial banks may be pressured to raise their retail deposit rates to retain savings deposits and MMDAs."
Among the "key takeaways" from the Fitch scenario is: "The pricing sensitivity of online deposits still remains relatively untested during periods of rising rates. Although deposit rate increases have been modest to date, Fitch expects additional U.S. rate hikes to result in more increases in deposit costs at online banks."
They add, "The combination of further Fed rate hikes, the beginning of the unwind of the Fed's balance sheet and the growing presence of high-yield online savings banks could pressure large U.S. commercial banks to increase deposit rates faster than historical experience. Retail deposit balances at online banks have grown 36% since year-end 2015, compared to 10% for large U.S. commercial banks over the same period. However, online banks still only have a 6% market share of U.S. retail deposits."
Finally, Fitch writes, "All banks could potentially experience less stickiness from retail deposits in the future due to disruptive technology. Services and resources that can help easily identify the highest savings deposit rates for consumers could aid in pressuring banks to offer more competitive rates to avoid losing this source of funding."
Fitch's release on European MMF Reform says, "Holdings in new forms of European money market funds will still typically be considered as equivalent to cash in Fitch Ratings' calculations of corporate net debt metrics and immediate liquidity resources."
It continues, "MMFs are typically treated as cash under our corporate rating criteria when they are located in developed jurisdictions and used by a corporate with broadly conservative financial policies. This reflects our view that they allow timely, unconditional availability of cash to the rated entity and offer reasonable certainty that the attributable value at par will be available. European MMF reforms being introduced could appear to challenge this view because they require some funds to either impose a fee or temporarily suspend redemptions if the fund's liquidity is too low. However, analysis of our rated European MMF portfolio suggests the likelihood of this happening will be very low."
Fitch writes, "The cash equivalence of MMFs is also a key question for companies' own financial reporting. Under IFRS, a "cash equivalent" instrument requires a very strong credit rating, WAM of not more than 90 days, insignificant risk of changes in value, a highly diversified portfolio, low liquidity risk and a way for the funds to benchmark returns (for example by reference to short-term money market interest rates)."
Finally, they comment, "The attractiveness of money funds to cash investors could be significantly reduced if there were a stricter application of the cash equivalent definition driven by management/auditor judgement or industry practice. But the reclassification of MMFs to the "investment" category from "cash equivalent" in a company's financials generally would not affect Fitch's classification of MMFs as cash in its corporate analysis."
