Ask any bank investor, and they will tell you that deposits are one of, if not the most, important thing to evaluate when looking at any bank stock.

Over the past couple of years, it may not have seemed that way because interest rates at the start of this year were at practically zero, which made funding extremely cheap. Funding was plentiful because the Federal Reserve up until recently had been pumping trillions of dollars of liquidity into the economy, which helped boost bank deposits. 

But now the Fed is unwinding its balance sheet and effectively pulling liquidity out of the economy, which will lead to a decline in deposits across the banking system. This makes sticky, low-cost deposit bases very valuable again. Let's take a look at which large U.S. bank has the best deposit franchise.

Stacking up deposit betas

One way to evaluate a bank's deposit base is to look at its deposit betas, which examines how much a bank will raise its deposit costs in relation to the Fed's interest rate hikes.

For instance, if the Fed raises its benchmark overnight lending rate, the federal funds rate, by 75 basis points (1 basis point = 0.01%), something it's done four times this year, and a bank has to raise its deposit costs by 75 basis points in roughly the same time period, that means that bank has a 100% deposit beta. This would be unfortunate because it shows the bank's entire deposit customer base was rate sensitive and it didn't have any meaningful relationship with its customers. Therefore, the lower the deposit beta, the better.

Now, let's take a look at the betas of the four largest banks in the U.S.: JPMorgan Chase (JPM 0.65%)Bank of America (BAC 1.53%)Citigroup (C 0.26%), and Wells Fargo (WFC 2.73%).

We'll do this by looking at the change in each bank's interest-bearing deposit costs relative to the federal funds rate through the first nine months of 2022. The federal funds rate went from 0.08% at the very start of 2022 to about 2.56% in September, for a total change of 2.48 percentage points. Bank management teams have much more sophisticated ways they can analyze their deposit bases, but this is a fairly simple exercise for retail investors.

Bank Interest-Bearing Deposit Costs, 1/1/2022 Interest-Bearing Deposit Costs, 9/30/2022 Change in Interest-Bearing Costs/Change in Fed Funds Rate (248 bps)
JPMorgan Chase 0.03% 0.73% 28%
Bank of America 0.05% 0.40% 14%
Citigroup 0.46% 1.68% 49%
Wells Fargo 0.04% 0.23%  7.7%

Data source: Bank financial statements.

As you can see, all of these banks other than Citigroup, which doesn't have the same kind of U.S. deposit franchise as the others, had virtually free deposit bases to start the year. But as rates have risen rapidly, Wells Fargo has had the best deposit betas through the first three quarters of the year.

Normally, Bank of America tends to have the best betas through the cycle. But this year was different, largely because Wells Fargo has been operating under an asset cap since 2018 as a result of the phony-accounts scandal that came to light in 2016 and has dogged the bank ever since.

Bank deposits have flooded the system in recent years as a result of the Fed pumping trillions of dollars of liquidity into the economy, which caused bank balance sheets to balloon. But Wells Fargo couldn't grow its balance sheet due to the asset cap, which allowed the bank to be really choosy about its deposit customers, according to Wells Fargo's Chief Executive Officer Charlie Scharf at a recent conference.

"And so, as we entered this period, what we said is we would have expected our deposit betas to be less than others have seen because they haven't had those limitations, and we have seen that," Scharf added.

Whose betas will continue to perform the best?

Bank of America is known for having better deposit betas through the cycle than JPMorgan Chase and Citigroup, although this emergence of Wells Fargo and the wild-card factor from the asset cap creates an interesting dynamic.

Bank of America and Wells Fargo are also quite alike in the sense that they both have large commercial franchises. Both management teams have also said that they think they can continue to increase net interest income next year from 2022 levels.

While I don't know if Wells Fargo will be able to maintain better deposit betas than Bank of America through 2023, I would expect both to have better betas than JPMorgan Chase and Citigroup.