May 5, 2023 - Economy

We can see the future, and it has bigger banks

Illustration of a piggy bank with a blue ribbon, as if it is a prize pig.

Illustration: Maura Losch/Axios

The current banking stress will amplify long-term trends toward consolidation, meaning banks are going to keep getting bigger.

The latest: Shares of regional banks continued to drop Thursday, after Canada's Toronto Dominion Bank gave up on a bid for Memphis, Tenn. based regional lender First Horizon, amid the tumult shaking U.S. banks.

  • First Horizon's share price dove more than 30%.
  • Other regional lenders like Huntington Bancshares fell more than 6%.
  • PacWest, the Los Angeles-based bank that has been in the markets' crosshairs, plunged more than 50%, after reports that it was considering a sale.

Between the lines: Regional bank share prices are getting a lot of attention. But the more important action may be going on in the bond markets, where you might can see the future of the U.S. banking system.

  • Bond markets help decide the borrowing costs for companies, including banks. And borrowing costs are a key to banks producing profits.

Yes, but: Banks borrow money from a lot of other places besides the bond markets — most importantly from depositors. Those borrowing costs are also going higher.

  • In fact, one of the ways to understand the torrent of deposits that have flown out of some regional banks, was simply because banks weren't paying depositors enough to hold onto their accounts.

Be smart: The basic business of a bank is to borrow money at a low interest rate — usually over a short time period — and lend it at a higher one.

  • The difference between the two rates is, essentially, the bank's profit.
  • If it suddenly becomes a lot more expensive to borrow —but the rates at which the banks lend don't go up—the banks make a lot less money.

State of play: Since Silicon Valley Bank imploded, the rate of interest regional banks pay to borrow has gone up a lot.

  • Meanwhile, the rate of interest that the safest giant banks pay to borrow, hasn't gone up that much.

What they're saying: "The combined headwinds from lower market capitalizations, deposit outflows, elevated funding costs, and downside risk for earnings will likely continue to pressure the balance sheets of small banks," wrote Goldman Sachs analysts in a recent note on credit conditions in the corporate bond market.

Translation: Small regional banks are likely going to be losing business to larger banks, where already-sizable advantages of scale just got larger.

Context: This isn't exactly a new development. Banks have been consolidating since the 1980s, and especially since the U.S. government did away with regulations barring interstate banking in the 1990s.

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