US banks ramp up borrowing amid reserve concerns, FHLB advances hit highest level since 2006

Major U.S. banks have increased their borrowing by 9%, or $70 billion, in August, as reported on Monday. This development follows decreases in borrowing during June and July, according to Federal Reserve data. The trend suggests commercial banks' discomfort with the depletion of their reserves as depositors migrate towards higher yielding alternatives. This information was detailed in a report by Citigroup Inc (NYSE:C). strategists Shuo Li and Jason Williams.

Simultaneously, the Federal Home Loan Banks (FHLB) system, a key liquidity source for banks, saw its total outstanding debt rise slightly to $1.249 trillion in August from $1.245 trillion in July. This increase aligns with the growing borrowing trend among large U.S. banks.

Depositors have been gradually withdrawing from banks of all sizes since the Federal Reserve began raising interest rates 18 months ago. The situation escalated in March with the failure of Silicon Valley Bank and several other institutions. Despite the subsiding turmoil, cash outflows continue, putting additional pressure on bank reserves which are also strained by increased U.S. government borrowing via Treasury securities.

The Citigroup report suggests that the recent surge in borrowing by major banks signifies their reluctance to allow their reserves to decline further from current levels. Financial experts on Wall Street estimate that the banking system's aggregate minimum comfortable level of reserves is approximately $2.5 trillion.

Between the upheaval in March and uncertainties tied to Basel III reforms, banks are inclined to maintain higher reserve levels than necessary and rely more heavily on home loan banks.

According to a recent Federal Reserve survey published in August, about 79% of respondents reported their institutions' preference to hold additional reserves above the minimum comfortable level. Nearly half of these respondents also indicated an increase in borrowing from FHLBs due to banking system stress experienced in March.

Currently, FHLB advances make up over 45% of bank borrowing, reaching the highest level since 2006, with the exception of Q4 2022 and Q1 2023. Despite this, Citigroup strategists believe there is ample scope for banks to further increase their borrowing from FHLB advances. This could impact investors in short-term debt like Treasury bills if FHLB issues more to meet bank demand for advances.

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