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Truist Financial (TFC -1.43%) has lost a third of its value in 2023. Almost all of that decline came during the bank runs that pushed a number of regional banks into insolvency early in the year. So far Truist has held up fairly well, all things considered. And yet 1.51% is a number that is still materially affecting the bank’s business.

What does a bank do?

In its simplest form, a bank takes in short-term deposits and then loans out those deposits long term to other people for things like mortgages. It pays interest to depositors for their cash. It charges interest on the loans it makes. Banks like Truist earn the difference between the interest paid and the interest earned. Modern banking is far more complex than this, of course, but this structure is still an important aspect of the industry.

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In the second quarter Truist paid interest of 1.51% on its deposits on average. That seems like a very small number. For depositors, historically speaking, it is pretty miserly. But it was up from 1.12% in the first quarter. That’s a 39 basis point increase in just three months, or roughly 35%. So while the absolute change doesn’t seem all that material, the percentage change is significant.

Simply put, the more Truist has to pay depositors, the harder it is for the bank to make money. The driving force here has been the Federal Reserve’s interest rate hikes. And to be fair, Truist doesn’t just have to pay more for deposits, it also gets to charge more for loans. So there’s an offset.

But there’s more to the story here than meets the eye.

Truist is facing a massive change

So that 39 basis point increase happened between the first and second quarters. The interest cost for deposits a year ago was 0.09%. That means that over the past year Truist has had to increase its interest payment to depositors by 142 basis points. That’s nearly 16 times higher! That’s a shocking change in just 12 months.

A good portion of this is related to the ultra-low interest rate environment that existed before the Fed’s rate hikes. Essentially any increase looks large when the starting point is close to zero. But it doesn’t change the impact that the change has had on Truist’s business. The rising cost of deposits is only one of them.

Another important factor to consider is the changes that its customers are making because they now have more attractive options. For example, why bother moving cash between a checking account that earns very little in interest and a CD that also earns very little in interest? But with interest rates rising, customers now have a reason to take action. Non-interest-bearing deposits, which includes things like checking accounts, dropped from $149 billion in the second quarter of 2022 to $124 million in the same part of 2023. That’s a nearly 17% decline. This is basically free money for the bank, and now there’s notably less of it.

But here’s where things get a little more interesting. Interest-bearing deposits rose from $275 billion to $276 billion. That’s a modest increase, but it tells you two things. First, customers are moving money out of non-interest accounts and into interest-bearing accounts now that there is a reason to do so. And competition between banks is heating up for deposits, which suggests that interest costs may not be done rising yet. 

Keep an eye on interest costs

To be fair, some of the decline in deposits at Truist is likely related to the bank runs that occurred earlier in the year. So the deposit changes may be exaggerated to some degree. But the interest cost issue is a major headwind. And while Truist isn’t unique in having to deal with it, rising interest costs for deposits will still have a material impact on the bank’s internal operations and its competitive position in the industry. If you own or are looking at Truist, 1.51% is a much bigger number than it may seem at first.