Banks continue to face the challenge of managing excess deposits while their customers are seeking fewer loans, reports the Federal Reserve Bank of Minneapolis.

Commercial banks in the Ninth District of the Federal Reserve Bank, have experienced unprecedented deposit growth and reduced demand for loans since the onset of the COVID-19 pandemic.1 These two forces caused considerable changes in the composition of assets on bank balance sheets, driven by cautious spending by depositors as well as pandemic-related relief efforts. Montana is part of the Ninth District.

The growth in deposits at Ninth District commercial banks has significantly outpaced growth in loans since the beginning of 2020. Pandemic relief efforts starting in the second quarter of 2020 contributed to the excess deposits, while pandemic-mitigating efforts and cautious consumer behavior curbed economic activity and lowered loan demand.

Excluding PPP loans, median year-over-year loan volume throughout the pandemic was largely unchanged. The PPP loan program allowed commercial banks to originate forgivable loans for businesses during the pandemic. Banks deposited the PPP disbursements directly into customer accounts. This contributed to the large increases in excess deposits in the second quarter of 2020 and again in the first quarter of 2021, when Congress made additional PPP loan funds available.

Regardless of growth in PPP loans, deposit growth since the fourth quarter of 2019 is significant across most banks. The median deposit growth rate continues to rise across different PPP proportions even as PPP loan volume has declined significantly. Besides PPP loans, other pandemic-related relief efforts and more cautious spending habits contributed to deposit growth.

The rate of deposit growth is more pronounced at banks with a higher percentage of PPP loans to total loans. Banks with a ratio of PPP loans to total loans that is greater than 10 percent report a median growth rate of 37 percent in total deposits since the fourth quarter of 2019, compared with 23 percent growth at banks with a ratio of PPP loans to total loans of 5 percent or less.

The rate of deposit growth moderated in the second quarter of 2021 for all PPP loan proportions because the program ended in the second quarter and the volume of PPP loans declined from approximately $30 billion to $19 billion quarter over quarter in the Ninth District (approximately $400 billion to $300 billion nationwide).4

The combination of relief efforts, shifts in spending by consumers and businesses, and the search for profitability in a low-interest-rate environment has led to significant changes in bank balance sheets in the district.

As expected, given deposit growth from bank customers, the amount of cash held by banks has grown significantly; recently, however, the trend has shifted to an increase in purchases of investment securities and a decrease in other borrowings. Banks have fewer options for deploying cash, given the limited demand for loans by their customers, so they have opted to increase securities and rely less on borrowings.

To fund loans during the pandemic, Ninth District commercial banks used more liquid sources—such as excess cash—while reducing borrowings. Shifting cash into securities improved revenue, and lowered borrowings reduced expenses. While the shift in assets and liabilities has improved liquidity risk at these banks, the more liquid assets are less profitable than loans.