With the Federal Reserve aggressively raising the federal funds rate, or the interest rate at which banks borrow from one another, banks will soon likely need to pay more interest on customer deposits.
A bank's deposit base is one of the most important characteristics that investors use. If a bank has a sticky deposit base that can maintain a cheaper overall funding cost than the average bank, investors will likely reward that bank with a higher valuation. That's because if deposit costs rise too quickly, it will cut into a bank's margins and reduce overall profitability.
So, with the Fed having already raised the federal funds rate to a range of 0.75% and 1% and rate hikes expected at all of the Fed's remaining meetings in 2022, let's take a look at which of the two largest deposit gatherers in the U.S., Bank of America (BAC -0.13%) and JPMorgan Chase (JPM 0.49%), has the superior deposit base. This is something very important to look at when choosing which of these stocks to invest in.
Image source: Getty Images.
Deposit summary
Not all deposits are treated the same. For instance, there are non-interest-bearing deposits, on which banks pay no interest. These are therefore the best kind of deposits, because it means the client has chosen the bank for something other than just pure yield. Non-interest-bearing deposits tend to come from average consumers and certain business banking relationships, typically those where there is a lending relationship as well.
Then there are interest-bearing deposits, which are those for which banks pay varying interest rates. These relationships can range from good to bad, depending on the interest rate paid. With that said, let's take a look at how Bank of America and JPMorgan's deposit bases stacked up at the end of March.
| Bank of America | JPMorgan Chase | |
|---|---|---|
| Total deposits | $2.05 trillion | $2.52 trillion |
| Interest-bearing deposits | $1.25 trillion | $1.78 trillion |
| Non-interest-bearing deposits | $798.8 billion | $734.2 billion |
| Cost of interest-bearing deposits | 0.05% | 0.04% |
| Year-over-year deposit growth | 13.4% | 13.1% |
Data source: Bank SEC filings.
Based on these statistics, the deposit bases look fairly similar. JPMorgan is bigger and has $530 billion more in interest-bearing deposits, which it has been able to gather at one basis point (0.01%) cheaper than Bank of America's interest-bearing deposit costs. But Bank of America has about $65 billion more of the ultra-valuable non-interest-bearing deposits. This isn't all that surprising because it runs a larger commercial operation than JPMorgan, which, as already noted, can bring in more non-interest-bearing deposits.
Another way to look at the quality of a deposit base is through deposit betas, which essentially measure how much a bank has to increase the interest it pays on deposits in response to a rising federal funds rate. We can look at the last rate cycle between 2015 and 2019 to get an idea of how much Bank of America and JPMorgan Chase had to increase the cost of their interest-bearing deposits in response to a rising federal funds rate.
| 2015 | 2016 | 2017 | 2018 | 2019 | |
|---|---|---|---|---|---|
| Federal funds rate | 0.20% | 0.55% | 1.33% | 2.40% | 1.55% |
| Bank of America | 0.12% | 0.13% | 0.23% | 0.51% | 0.73% |
| JPMorgan Chase | 0.11% | 0.15% | 0.29% | 0.57% | 0.81% |
Data source: SEC filings.
Calculating deposit betas can be a very complex process, and banks also have different formulas. So, I am going to use a very, very simple formula just to provide an idea. Basically, we can take the rate of change in each bank's cost of interest-bearing deposits over the change in the federal funds rate. We'll look at deposit betas between 2016 and 2017, and between 2017 and 2018, because those years had the biggest swings in the federal funds rate.
Between 2016 and 2017, Bank of America had a deposit beta of 12.8%, compared to JPMorgan at 17.9%. The lower the beta, the better, because it implies a smaller rise in deposit costs. Between 2017 and 2018, Bank of America and JPMorgan Chase both had a deposit beta of 26.2%.
More recent developments
Since the start of 2020, about $4.8 trillion in deposits has flooded the U.S. banking system, largely due to quantitative easing and built-up savings from the pandemic. This has ballooned bank balance sheets and also led many to wonder how much of these deposits will stick around as the Federal Reserve begins unwinding its nearly $9 trillion balance sheet and pulling liquidity out of the economy.
Additionally, data from the FDIC showed that JPMorgan grew its U.S. deposit market share from 10.94% in 2020 to 11.67% in 2021. Meanwhile, Bank of America saw its deposit market share fall from 11.09% to 10.86%, despite growing deposits solidly that year.
Bank of America, however, looks to have significantly improved its deposit base in recent years. In a research note from March, Wells Fargo analyst Mike Mayo wrote that about half of Bank of America's $2 trillion-plus deposits are low-cost retail deposits. Mayo also called Bank of America one of the "greatest fintech players on the globe." The bank has invested significantly in technology in recent years, and last August Bank of America announced that 85% of deposit transactions were being made digitally.
On its most recent earnings call, JPMorgan CEO Jamie Dimon said the bank didn't expect betas to be too different from the last rate-hiking cycle, but it's definitely hard to know exactly, given all the moving pieces right now. Bank of America's CFO Alastair Borthwick said the bank expects its deposit betas to perform a "little better" during the second 100 basis points (1%) of rate hikes, but also acknowledged that "it's difficult to project out first 100 versus [the] second 100."
Who has the better deposit base?
Although both banks have very strong deposit bases and more deposits than they know what to do with right now, I would give a slight edge to Bank of America in terms of having a more stable and sticky deposit base. Bank of America's technology investments seem to be paying off, and the bank has more non-interest-bearing deposits than JPMorgan.
Based on management's comments, it seems like Bank of America also feels more confident that it can improve betas from the last rate cycle than JPMorgan, and it held deposit costs lower in the last cycle. That's not to say that JPMorgan has a bad deposit base. I expect JPMorgan's base to remain fairly stable, and the bank did grow its U.S. deposit market share.
Ultimately, I think the real questions for both banks will boil down to how the reduction in the Fed's balance sheet and the more aggressive hikes during this cycle affect deposit betas, which is much more unclear right now.
