Research — 1 Feb, 2023
Liquidity pressures put funding in the crosshairs at community banks
By Nathan Sovall
Highlights
Community banks began to feel greater pressure on liquidity in the late summer, though, as depositors began to more actively move funds to their higher-yielding alternatives offered in the Treasury and money markets.
We expect CD balances and borrowings from the FHLB to steadily grow in 2023 as community banks seek to fulfill their liquidity needs, translating into notably higher deposit costs for the group.
Credit trends remain benign, but there are signs of weakness in the market, with an increasingly inverted yield curve, which is often a precursor of a recession.
Rising funding costs and growing liquidity pressures at community banks will begin to stand in the way of additional net interest margin expansion in 2023.
Healthy loan growth, higher interest rates and modest increases in deposit costs have resulted in far stronger community bank margins in 2022. However, liquidity pressures have begun to emerge and will cause community banks to record notably higher funding costs in 2023 as institutions increase their reliance on more expensive wholesale funding and CDs. Credit costs will also rise off historically low levels serving as a headwind to earnings but are expected to fall short of losses witnessed during a severe downturn.
