Bank teller
iStockphoto/Fly View Productions

The cost of U.S. bank deposits is likely to keep rising, pressuring banks’ margins and earnings, suggests a new report from DBRS Morningstar.

The rating agency examined deposit trends in the U.S. banking industry, amid the ongoing rate hiking cycle — concluding that banks will likely have to keep increasing the rates they pay on deposits in the current rate environment.

It said the prospect of rates staying higher for longer is likely to lure consumers out of bank deposits and into higher-yielding alternatives, such as money market funds.

“From a depositor’s perspective, after a prolonged period of low interest rates, the opportunity cost of not looking for better yielding alternatives remains high, which will likely continue to drive up deposit rates as banks recalibrate to maintain the competitiveness of their deposit products,” the report said.

Additionally, bank deposit rates have yet to catch up to the rate hikes delivered by the U.S. Federal Reserve Board, it noted — so there’s likely more room for banks to increase their deposit rates, which will continue to increase their funding costs, and pressure bank profits.

“Profitability headwinds were inevitable as the industry’s dependence on deposit funding comes head on with the latter stages of the most aggressive rate hike cycle in 40 years” said Eric Chan, vice president, global financial institutions group, at DBRS, in a release.

“Even assuming no more Fed rate hikes, we believe the industry’s deposit rate has yet to fully catch up with Fed funds, likely resulting in a continued drag on profitability,” he added.

The report noted that already the U.S. banks have seen their deposit levels as a share of total assets decline from a high of 83% in the first quarter of 2022, down to 80% in the second quarter of this year.

“Total deposit levels have since trended lower given recent outflows while remaining above pre- pandemic levels,” it said.

Indeed, banks remain far more reliant on deposits for funding than they did back in the days before the global financial crisis, when their deposits only represented about 64% of their assets, the report said.

According to DBRS, the financial crisis drove a fundamental shift away from wholesale borrowing and towards deposits as a greater source of bank funding.

Now with banks much more reliant on deposits, “the U.S. banking industry is facing a battle against the growing cost of maintaining and growing deposits,” it said.