OREANDA-NEWS. As short-term US interest rates eventually rise, some large US banks intensely focused on managing their Liquidity Coverage Ratio (LCR) requirements may choose to re-price their high-quality deposits relatively quickly, thus curbing the recovery potential for net interest margins across the US banking sector, says Fitch Ratings.

Consistent with Fitch's expectations detailed last September in "Regulatory Rule Furthers Bank Liquidity Measurements," many large banks have focused on optimizing their liabilities in response to LCR rules. This has included attracting more deposits that are treated favorably under the LCR, such as core deposits and/or clients' "operational" deposits, while also reducing deposits treated punitively, such as "nonoperational," uninsured deposits. Among those banks subject to the enhanced supplementary leverage ratio (SLR), the heightened attention to regulatory compliance provides another incentive to optimize deposit mix.

In accordance with LCR rules, several of the largest US banks have already taken steps to reduce deposits defined as "nonoperational," which have a run-off assumption of 40% if not insured. Examples of these types of deposits include funding from wholesale clients, deposits from financial institutions, and cash balances maintained for large clients above the FDIC insured limits. At the same time, banks are also taking actions to attract LCR-friendly operational deposits, which have a 5% run-off assumption, as well as retail deposits, which have a 3% run-off rate.

JPMorgan Chase has shed over $100 billion in nonoperating deposits since the beginning of the year, while continuing its focus on growing core operating deposits. Similarly, Wells Fargo reduced nonoperational deposits during the quarter, while continuing to accumulate retail deposits, making overall deposit balances somewhat flat relative to the sequential quarter. Other banks signaling continued deposit optimization include Bank of America, U.S. Bancorp, State Street Corporation and Bank of New York Mellon.

Deposit optimization has generally been accomplished through changes to deposit pricing, whereby banks have lowered pricing on nonoperational deposits, or in some cases have begun charging fees on these accounts. Fitch expects more of this activity going forward, particularly following an interest rate increase. We also expect elevated deposit price competition will likely occur over a medium-term time horizon.

One potential implication of regulatory-influenced deposit pricing dynamics is that interest rate sensitivity projections may make the choice of deposit betas (the responsiveness of deposit rates to changes in market interest rates) used in interest rate sensitivity forecasts more difficult to estimate. This is further compounded by the duration of very low interest rates and technology enabling easy money movement, both of which makes historical data previously used to compile deposit betas less relevant. Should the actual deposit betas wind up being higher than some current estimates, the effect will be added weight on potential NIM expansion.