Apps, crypto, even Starbucks cards: Deposit fragmentation has been on a decade-long mission to bring down banking — and it’s not done yet

by Arthur · March 24, 2023

Even retail apps like Starbucks, Chick-fil-A, online gaming apps, and many others pull money from traditional banks. Getty Images

With the news of Silicon Valley Bank’s failure, people are wondering about the safety of our financial institutions. But the reality is that banks fail surprisingly often. The difference with SVB is that its sudden demise affected a large number of well-known brands, startups and venture capital firms who all had full confidence in their financial partner. And there are concerns that “herd mentality” could lead to other companies taking deposits from other financial institutions, creating a domino effect.

So, should we be worried? Yes and no.

The reason banks fund the Federal Deposit Insurance Corporation (FDIC) is to protect against situations just like Silicon Valley Bank. Depositors should all get their money back, without demanding a tax-funded bailout from Americans. So in the short term this will (hopefully) be a blip on the financial radar and a major inconvenience for the companies affected, but it’s not going to bring down the entire economy.

But what about the long term? Are the banks healthy?

It is a more complicated question. Over the past 10 years, many more non-traditional financial institutions have emerged. We have companies like Robinhood and Acorn, mobile banks like SOFI, Chime, GO2Bank and even cryptocurrency. More consumers are loading their paychecks onto prepaid debit cards that aren’t aligned with traditional banks.

Perhaps surprisingly, even retail apps like Starbucks, Chick-fil-A, online gaming apps and many others are siphoning funds away from traditional banks.

Deposits are becoming highly fragmented, and fewer are going to traditional financial institutions. Traditional banks and credit unions have experienced an exodus of deposits, and the consequences are beginning to show.

Market fragmentation wasn’t too much of a concern when the banks were flush with stimulus checks and PPP money. According to the Federal Reserve, consumers saved more money during the pandemic than ever likely because of a sharp reduction in travel, commuting, shopping, entertainment and other expenses, as well as by saving what they received in COVID-19 stimulus checks.

Indeed, during this time, personal savings increased, and the Fed estimates that US households accumulated about $2.3 trillion in savings in 2020 and through the summer of 2021. All of this activity fueled significant institutional growth with historically high lending volumes.

But in the winter of 2021, there were reports that those savings were falling, especially among lower-income families who used those emergency funds to get by.

Shortly after, in 2022, the decision came to raise the interest rate, which until then had been close to zero. The rising interest rates were designed to tame inflation, but they also created another slowdown in home purchases, discretionary spending, mortgages and bank income streams, creating an unusual period of stagnant growth.

More worryingly, a number of traditional financial institutions have remained complacent, despite this shift in financial dynamics. A chaotic economy, lingering worries about a recession, and the growing skepticism of businesses and consumers in the wake of recent bank failures mean there are even fewer deposits flowing in to fill the widening gap caused by fragmentation.

Like a glass after it has been broken, there is no way to put the pieces back together. We are not going to defragment the banking industry and reduce the deposit gap by eliminating other financial options.