Modern urban skyscrapers in downtown Chicago from below to the blue summer sky. Sun reflecting in the glass facades of the urban futuristic buildings. Chicago, Illinois, USA

The prospect of an extended period of higher interest rates is likely to lead to liquidity pressures at U.S. banks in the year ahead, Fitch Ratings says in a new report.

Citing the growing probability that the U.S. Federal Reserve will keep rates higher for longer, the rating agency said banks are set to face higher funding costs and shrinking deposits.

“Weaker credit performance is expected to be the primary focal point for U.S. banks’ financial performance in 2023, but the industry response to meaningfully declining deposits will also be an important issue to monitor,” it said.

Fitch said it expects bank deposits to “shrink meaningfully through 2024, as depositors seek higher-yielding alternatives.”

The rating agency currently expects deposits to decline by US$1.6 trillion in 2023 and by another US$1.4 trillion in 2024.

Bank deposits were US$7.4 trillion at Sept. 30, 2022, it noted.

As deposits decline, some banks could face growing liquidity pressure, the report said.

“Banks with stronger core deposit franchises will be less vulnerable to liquidity challenges,” it said, whereas banks that see strong loan growth, while deposits are declining, may face liquidity challenges as they must turn to higher-cost funding alternatives.

That said, given that banks’ liquidity positions are generally strong to start, Fitch said it doesn’t currently expect many downward credit rating actions in 2023 due to the expected rise in liquidity pressures.