Accountant with calculator and wooden percent sign on desk

Small and regional banks are finding they have to pay higher interest rates on deposits to keep their customers.

Banks grew accustomed to paying literal pennies a year in interest for many accounts when the U.S. Federal Reserve held rates low in recent years, then cut them to rock bottom during the COVID War.

The central bank’s interest rate has risen over the past year, but rates have changed little at many banks. As a result, savers and businesses have moved their cash to money market funds, where they can earn more than 3 percent, compared to less than 1 percent at their old banks.

Also, the recent turmoil in banking set off by the simultaneous collapse of Signature and Silicon Valley banks rattled depositors. Many shifted their accounts to giant banks they consider safer because they remain “too big to fail.”

Losing deposits can drop banks’ cash to dangerous levels, risking instability as well as regulatory warnings.

To keep more depositors from fleeing, banks are beginning to reward them for staying.

Banks are learning the hard way.

At the end of March, deposits at Zions Bancorp numbered 3 percent fewer than during the previous quarter and were down 16 percent from a year earlier. More than two-thirds of the lost accounts held $10 million or more, the bank reported.

Also in the first quarter, the bank borrowed $11.5 billion more than in the same period in 2022, mostly from federal home loan banks.

The bank’s first-quarter results were “sound,” CEO Harris Simmons said in a statement, but he also noted “concerns about liquidity and capital strength in the wake of two prominent bank failures in mid-March.”

Citizens Financial Group also saw its number of deposits shrink last quarter, largely as a 10-percent drop in accounts that did not earn interest.

Banks had not expected the degree to which higher interest rates would force them to raise the interest rates they pay, Citizens CEO Bruce van Saun said to The Wall Street Journal.

Citizens paid an average rate of 1.74 percent in this year’s first quarter, an increase of more than half a percentage point from the fourth quarter of 2022.

At Hancock-Whitney, a Mississippi bank holding company, the number of deposits increased 2 percent in this year’s first quarter after the bank raised the interest rate it offered from an average of 0.96 percent to 1.65 percent.

The tumult that shook the banking world after Signature and Silicon Valley banks failed “is going to be most challenging for small and mid-size banks,” Terry Dolan, CFO at U.S. Bancorp, told the WSJ.

“They tend to be less diverse or concentrated in particular areas,” he noted.

TREND FORECAST: Banks are making fewer loans, as we report in “Loan Availability Has Tightened in Key Markets, Fed Report Shows” in this issue.

At the same time, small and regional banks will have to pay more interest to keep customers from shifting their money to megabanks they believe to be safer.

That will leave many smaller banks less profitable, making them prey to takeovers by larger banks.

We forecast an uptick in bank buyouts this year as weaker small banks are subsumed by larger ones.

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