Garnet Capital Advisors Blog

Of the many predictions and forecasts experts made on COVID-19’s effects and its subsequent lockdowns on the Financial Sector, very little light was shed on the excess liquidity that may result from it. A year later, banks are still grappling with excess deposits that have grown at an alarming rate. 

With another stimulus right around the corner, excess liquidity issues are just beginning, and banks have to be on the lookout for solutions. 

Rise Of Deposits During The Pandemic 

The rise of deposits during the COVID-19 pandemic has been as unprecedented as the pandemic itself. Statistics show that industry-wide assets grew a stunning $663.45 billion to finish the 4th quarter at $21.883 billion. 

For the record, this is the third-largest asset growth in recorded history, trailing closely behind the $884.76 billion in 20Q2 and 1.608 Trillion in 20Q1. 

Causes Of Excess Liquidity 

Since the end of March 2020, deposit balances at US banks have grown to $1.874 trillion. An asset flow of this magnitude is unparalleled in recent history. 

To put this into context, banks saw a 1 Trillion dollar increase in deposits in Q1 2020 compared to $260 billion in Q4 2019. 

What may have caused such an unparalleled increase in bank deposits over the past year? 

Some of these causes include: 

1. Fiscal And Monetary Stimulus 

Behind this increase of deposits is the aid and fiscal stimulus the government has offered small and medium-sized businesses to shield them from economic shutdowns. 

2. Economic Shutdowns 

COVID-19 and its resulting shutdowns blew many individual and business plans out of the water. Many businesses and individuals have chosen not to spend this year as they wait and see what the future holds.

Most of the money that was supposed to be spent in 2020 by businesses and individuals has washed up in banks as deposits. These deposits are piling up at unprecedented rates. 

3. Changing Trends In The Lending Ecosystem 

Trends in the lending atmosphere are also partly to blame for the excess deposits banking institutions are grappling with. 

Most lenders now prefer to deposit their savings in legacy banks, but have opted and for borrowing from quicker online lending sites. Digital lending is on the rise. 

This has left banks with excess deposits, all the while starved for loans. 

Why Liquidity is A Problem This Time 

In other circumstances, excess liquidity and deposits are a highly welcome scenario for banks and financial institutions. After all, they enable banks to make more investments and lend more at rewarding rates that lead to increased profits and margins. 

Not this time. This is because of: 

Economic Inactivity 

With the US economy at its lowest since the Great Depression, the demand for loans is also incredibly low. This makes it difficult for banks to convert their existing cash piles and deposits into loans and reduce their excess liquidity. 

Low-Interest Rates 

The COVID-19 Pandemic saw one of the lowest interest rates in history. This made it expensive for banks to hold assets in a market with low demand for loans. 

Economic Stimulus 

In times of economic hardships, many institutions and individuals turn to lenders and banks for short-term relief, creating a healthy demand for loans in times of crisis. 

This time, however, the government kicked in with its rounds of stimulus checks. This move hence reduced the much-needed demand for loans, making it even harder for banks. 

Options For Banks With Excess Liquidity

Banks and lending institutions have a variety of options to increase the ratio of their loans to deposits and reduce their excess liquidity. These are: 

• Buy: Banks have the option of purchasing high-quality loans from other financial institutions that have a surplus of loans. Commercial loan sales offer a reliable option for banks to purchase loans. 
• Build: If the wave of borrowing favors online lenders, banks can opt to build their own online-lending portfolios and benefit from the increased lending in these platforms. 
• Partner: The market is awash with small and digital lenders seeking partnerships from large banks. Banks can partner with these lenders and channel their liquidity through these lenders. 

The Need For Banks To Partner Or Purchase High-Quality Loans 

The need for banks to purchase high-quality loans has never been this apparent. This COVID-19 Pandemic has shown the importance loan purchase and partnerships have in the survival of a financial provider. Banks need high-quality loan purchases because: 

Increased Cash Flow From Loan Portfolios 

When all is said and done, bank margins originate from loans. The purchase of high-quality loans gives banks access to loans that may turn into margins in the future. 

Regulatory Hurdles 

Holding large assets with little or no lending comes with its fair share of regulatory hurdles. Partnering and purchasing loans help financial institutions steer clear of some of these regulations that consume both time and money. 

Reduce Ratio Of Non-Performing Loans 

During the COVID-19 pandemic, the ratio of performing to non-performing loans has declined due to an increase in loan forbearance and default. Loan purchases and partnerships enable banks to increase their amount of high-performing loans to a healthy level. 

Reduce Drag On Margins 

Most of these bank deposits have been placed in low-yielding investments, putting a drag on banking margins. Partnering with lenders or buying high-quality loans enables banks to put their assets in high-yielding investments that increase margins.

The Importance Of Loans Purchases And Partnerships Cannot Be Overstated 

High-quality loan purchases and partnerships will play a significant role in pulling financial institutions from this unprecedented increase in liquidity. 

For more information on the essence of loan purchases in financial institutions, contact Garnet and let us be part of your story.