Rising interest rates should help banks’ profit margins, right? It depends on a number of factors — not least of all banks’ ability to hold the line on deposit prices.

In the last cycle, deposit costs lagged short-term interest rates on the way up and on the way down. The following graphic shows funding costs over time for different categories of deposits and other forms of financing on one tab, and data on the industry’s funding mix over time on the other. (Text continues below.)

Rates on total domestic deposits, based on the median for about 7,000 banks in operation as of July, bottomed at 1.41% in the second quarter of 2004 and rose steadily through 2007.

A quarterly average of daily quotes for 3-month Treasuries bottomed out a quarter earlier, in the first quarter of 2004, and also rose steadily through 2007.

The downturn in rates on total domestic deposits began in the fourth quarter of 2007 — two quarters after yields on 3-month Treasuries began to decline.

Long-term certificates of deposit could explain some of the stickiness, particularly on the way up. CDs maturing in 1 to 3 years funded 3.4% of industrywide average earning assets in the second quarter of 2004, when short rates had started their ascent. That’s a relatively high proportion during the time considered here. (See the second tab of the graphic above.) CDs maturing in more than 3 years funded 1.6% of earning assets in the second quarter of 2004, also a relatively high proportion.

Long-term CDs could help again: they’re currently close to their levels in early 2004.

Overall, long-term CDs have not accounted for a large proportion of bank funding, however, with a maximum of about 5% of earning assets for those with maturities longer than 1 year since mid-2004.

Total time deposits have consistently been far more expensive than savings deposits, which is the largest category of bank funding.

At the widest gap during the last tightening phase, rates on savings deposits were about 300 basis points below yields on 3-month Treasuries from 2006 through early 2007. Time deposits cost about 50 to 90 basis points less than the 3-month T-bill during the same period, and levels of time deposits were relatively high, funding about 23% to 24% of earning assets from 2006 through late 2009.

The costs of funding instruments like federal funds and repurchase agreements — categories that have fallen sharply as a percentage of earning assets — and foreign deposits, which are concentrated at the largest banks, track closely with short-term interest rates.

The other half of the picture for banks depends on how revenues react to rates, of course. The jump in longer-term rates stands to hammer mortgage production earnings, but offers opportunities to invest in higher-yielding securities.

Like most deposits, large pools of adjustable-rate loans tied to short-term yields will not move without a shift in the short end of the curve, which could be far off. In June, 15 of the 19 participants in Federal Reserve policymaking discussions did not expect the central bank’s target rate for overnight loans of bank reserves to increase before 2015.


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