Banks Face Pressure to Hike Deposit Rates After Holding Back

As interest rates rise, banks are facing pressure to change their longstanding practice of paying depositors practically nothing.

Key TakeAways

• Despite the Fed raising its benchmark interest rate by 5 percentage points through March 2022, banks have been slow to offer higher interest rates to depositors.

• Banks are able to keep rates low because many customers don't shop around for better deals.

• Increased competition on rates, as well as recent bank failures, have prompted banks to offer more high-yield options and may encourage them to raise interest rates on more types of accounts. {alertSuccess}

The Federal Reserve raised its benchmark fed funds rate for the 10th time in a year on Wednesday, bringing its benchmark fed funds rate to a range of 5% to 5.25%. Till Wednesday, banks could collect 4.82% interest on money deposited with the central bank.

Banks raise their key rates in lockstep with the Fed, the rate at which they lend money.

Meanwhile, banks offered an average of 0.39% interest on savings accounts to their depositors, according to data from the Federal Deposit Insurance Corporation.

What The Banks Get vs What They Pay You ?

Banks can take the money you deposit and put it into an account with the Federal Reserve to charge interest at the overnight funding banking rate. In return, the interest they pay to individual customers is in most cases very low.

Account Type	Interest Rate
Overnight Funding Banking Rate	4.82%
Interest checking	0.06%
Savings accounts	0.39%
3-Month CDs	0.78%
12-Month CDs	1.54%

Chart: Faruk Techker / Faruk Abdulla 

Source: Federal Reserve; Federal Deposit Insurance Corporation

 

Difference in rates can mean significant amount of money for saving or lost money. A savings account with a $ 26,000 balance - the average price of a specific American family financial property by 2019 - an average savings account of 0.39% by 2019 will increase to $ 27,034 in 10 years at an interest rate.

The figure would be $ 42,061 if the account paid 4.82% over the same time.

Anyway, how the banks have gone away from being so stingy with their interest rates, and how long can it last?

Raymond James Chief Economist Youenio J. Aleman said that a major factor keeping the rates below is the loyalty of the customers.

"People would really require a huge increase in rates to replace banks," he said. "For many years, they have worked with the belief that American banks will not change ... people either do not know or they are very lazy to open an account in a separate bank."

This may help explain why average rates remain low despite some banks—particularly online ones—offering much higher rates in an effort to lure customers.

Research by economists at the Federal Reserve Bank of New York supports the notion that banks have been slow to raise interest rates offered on savings accounts and certificates of deposit, even as the Fed is in hiking mode.

However, banks have many reasons to change their ways.

For one, the fate of Silicon Valley Bank, which was mired in a classic bank run in March when depositors fled en masse, serves as a reminder that banks should be careful not to hold onto their deposits. Rates should be raised, Aleman said. Alleman said that the higher rates get, the more competition will force banks to either raise rates or lose everything.

Interest rate hikes and banking turmoil have changed customer behavior somewhat and prompted banks to offer more high-yield savings accounts, said Jennifer White, senior director of banking and payments intelligence at JD Power. has prompted.

"As interest rates rose, shopping increased and high-yield accounts (HYAs) opened. When banks could offer the HYA option to their existing customers, many customers remained loyal," he wrote in an email. “Even as HYAs begin to grow rapidly or weeks after a bank failure begins, a high proportion of customers remain loyal to their primary bank. They may transfer deposits to secondary institutions, but their primary The relationship is not causing a significant increase in the attrition rate."

A survey conducted by JD Power in April showed that the share of bank customers transferring money had increased slightly: 29% of bank customers had moved an average of 39% of their deposits to a secondary account in the past 90 days. Had given. compared to 27% who did so in March 2022. According to an online survey of 4,000 US adults, 29% of money movers said they were chasing higher interest rates in March 2022, up from 25%.

There is also pressure from the government and the workers. In November, Senator Jack Reed, a Rhode Island Democrat, sent a letter to major banks demanding they explain why they were still paying such low rates to savers.

And some advocates have renewed calls to allow individuals to bank with the Fed and collect those higher interest rates themselves, effectively putting banks out of the retail savings business.

There are signs that the tide is turning, at least for some depositors. Aleman, who had been keeping money from selling her home last year in a savings account, saw the monthly interest amount jump from $8 to $800 over the three months ending in December.

"My guess is they're going to start raising interest rates for people who have a lot of money," he said.

"Basically, they are discriminating because of the size of the savings account. But I think we should start seeing an increase in savings rates in the banking sector soon."