Higher interest rates, an inverted yield curve, declining deposits, higher cost of funding, and compressing net interest margins – at least among some banks – were key risks to banks that developed in 2023, according to a report issued Wednesday by the federal insurer of bank deposits.
In its 2024 Risk Review, the Federal Deposit Insurance Corp. (FDIC) said the decline in bank deposits and “a shift toward higher-yielding deposit accounts” put upward pressure on bank cost of funds and interest expense. “In response, many banks reduced securities to fund deposit outflows, pledged securities to ensure access to liquidity lines, and turned to higher-cost borrowings to cover anticipated liquidity needs,” the report states.
It notes that community banks have increased their reliance on wholesale funding to support strong loan growth, resulting in weakened liquidity positions to year-end levels at their lowest since 2009.
The industry’s net interest margin increased in 2023 despite rising funding costs and an inverted yield curve, the report states, but margin changes varied across the industry.
“Banks continued to hold an elevated share of long-term assets overall, putting pressure on margins in a higher-rate environment, but some banks began to sell off lower-yielding securities to reinvest at higher rates,” the report states. “Net interest margin compression contributed to a larger share of unprofitable community banks in 2023.”
The annual Risk Review outlines banking conditions in 2023 in five broad categories: market risks, credit risks, operational risks, crypto-asset risks, and climate-related financial risks. The FDIC said that the market risks areas discussed are liquidity, deposits and funding, and net interest margins and interest rate risk. The credit risks areas discussed are commercial real estate, residential real estate, consumer, agriculture, small business, corporate debt and leveraged lending, nonbanks, and energy. The discussion of operational risks examines the potential negative impact to banks from cyber threats and illicit activity. The crypto-asset risks section discusses the FDIC’s approach to understanding and evaluating crypto-asset-related markets and activities. The discussion of climate-related financial risks focuses on the physical risk of severe weather and climate events to the banking system.
Monitoring these risks is among the FDIC’s top priorities, the agency said.