As multiple crises roiled the Western banking industry this month, investors yanked money from bank accounts and stashed it in money market funds.

During the first two weeks of March, regional banks saw $161 billion in deposits go elsewhere. For the entire month of March, money market funds collected $340 billion, according to the Financial Times.

In the week ended 18 March, average deposits by businesses were down 2.16 percent, according to research firm Curinos, more than triple the outflows seen from 1 January through March 10.

In addition to appearing less turbulent, money market funds also are paying higher returns than most banks.

“People that were making half a percent in bank accounts were ignoring the 4 percent they could make in money market funds,” Doug Sprately, head money market trader at T. Rowe Price, told the FT. “Now they just got a big, swift kick in the pants.”

Treasury Secretary Janet Yellen cautioned against the rush to money markets.

“If there is any place where the vulnerabilities of the system to runs and fire sales have been clear-cut, it is money market funds,” she said in 30 March comments to a National Association of Business Economics conference.

“The financial stability risks posed by money market and open-end funds have not been sufficiently addressed,” she warned.

The flight to money market funds has worsened the plight of banks, especially smaller ones: their costs have risen, their portfolios of government bonds have lost value, and their operating margins have tightened.

In addition, March’s array of banking emergencies may cause regulators to require banks to keep a larger cash cushion.

The result: smaller and regional banks especially are unable to match money market funds’ interest rates on deposits. If they do raise the amounts they pay to depositors, they have less cash.

The less cash they have, the fewer loans banks can make, hampering business activity and economic growth.

Small and regional banks already are spooked. After seeing depositors suck $2 billion out of Silicon Valley Bank in a single day, more banks are keeping more cash on hand, The Wall Street Journal noted, at least until depositors’ jitters are well past.

Also, money market funds routinely store cash overnight at the U.S. Federal Reserve where they earn generous interest rates. Current daily deposits are around $2.3 trillion, the FT reported.

That money would otherwise be available to banks to lend, fueling economic growth, and to safeguard themselves against runs.

The cash flooding the funds, combined with their heavy use of the Fed’s overnight depository, is “an accident waiting to happen,” Andrew Levin, a former Fed official who teaches at Dartmouth College, said to the FT.

“Ironically for the Fed, which wants to help the banking system and keep it safe, its own facility winds up being the weak link in all of this,” he added.

Money market funds typically invest in short-term government securities. As a result, investors are likely to see their rates of return grow smaller if, as expected, the Fed begins cutting interest rates next year.

However, that does not mean cash will migrate back to banks, especially if depositors have concerns about their safety, money markets chief Joseph D’Angelo at PGIM Fixed Income, said in an FT interview.

“You’re not going to necessarily see [bank] deposit rates come up,” he said. “In all likelihood, I don’t see a lot of movement [of cash] back to banks.”

TRENDPOST: The banking crisis is turning into a small business crisis.

Community banks “are the heart and soul of small business lending,” finance professor Rebel Cole at Florida Atlantic University told the WSJ.

Banks with less than $10 billion in assets held about 43 percent of all small loans to businesses at the end of last year; in contrast, the 13 largest banks made less than 23 percent of those loans.

“When the local bank disappears, people and businesses in their communities often find that credit goes away, too,” the WSJ noted.

More than 9,000 smaller banks have vanished in the past 30 years, most absorbed by bigger institutions. Bank of America and JP Morgan Chase together now hold about 25 percent of all bank deposits in the U.S., according to the WSJ.

The more money that migrates to money market funds and other non-bank accounts, the less business activity our communities will see, the fewer jobs there will be, and the U.S. will move deeper into Dragflation… and worse.