The Truth About Bank Deposits, Interest Rates, and Benefits to Consumers

The Truth About Bank Deposits, Interest Rates, and Benefits to Consumers

In his article, “Big Banks, Not Savers Get Payday from Deposits,” Stephen Gandel makes an accurate observation about deposit rates and then draws some odd conclusions from it.  Because the topic is interesting, a response is in order.

The Core Issue

It is correct, as Mr. Gandel observes, that deposit betas have recently been low:  that is, the average deposit rate paid by banks has not risen as quickly as overnight money market interest rates such as the federal funds rate.

This result was widely expected, however.  To explain, the interest rates that banks pay on retail deposits are normally less than market interest rates such as the overnight fed funds rate (the unsecured interbank rate) or the overnight Treasury repo rate (the interest rate on a loan to a financial institution secured by Treasury securities).  For example, over the 10 years prior to the crisis interest rates on money market deposit accounts at commercial banks averaged about one percentage point below the fed funds rate.

Deposits rates sit below market rates because deposits aren’t just an investment, they are also a means to make payments unlike alternatives such as Treasury bills. Businesses and households value the liquidity of deposits, and the convenience and safety of not having to keep stacks of cash on hand.  Those payment services are part of the compensation, in addition to interest, that depositors receive in exchange for loaning the bank their money.

At the end of 2008, all interest overnight interest rates fell to zero.  It’s tougher to offer deposit rates below zero (though a few did try), so deposit rates ended up in the same place as market rates, and they all remained at essentially zero through December 2015.  Over the past 2½ years, market rates have been rising gradually, and the fed funds rate is now nearly 2 percent.  Deposit rates, by contrast, have risen less than 1 percentage point.  As short-term rates continue to move up, we expect the spread between the fed funds rate and the retail deposit rates to continue to rise and return to its historical long-run value.

Thus, the current low deposit betas that Mr. Gandel cites are no surprise.  Ironically, there actually is currently a lot of debate (and some concern) about whether that trend is about to end. Some expect that deposit rates will rise closer to market rates because Federal Reserve liquidity rules provide banks strong incentives to fund themselves with operational deposits, including insured retail deposits.  (These deposits are quite sticky; the deposits that ran in the crisis generally were corporate, non-operational deposits – that is, uninsured deposits held for convenience and not to fund regular transactions.)  Because those liquidity rules apply only to large banks, analysts expect them to offer higher interest rates to continue to use operational deposits as a source of funding.  So, it is quite likely that the trend that Mr. Gandel decries will reverse, which would be bad news for community banks, who are more reliant on deposit funding than large banks, and would be forced to pay higher rates to keep them.

The Role of Deposits, and Consumer Demand for Them

That said, even if one presumes that low deposit betas will continue for all banks, and that the largest banks will continue to pay lower deposit rates than small banks, we see no cause for suspicion, yet alone alarm.

Deposit Betas are not a Sign of Perfidy

Mr. Gandel states that by his calculation “83 percent of the gains [from the Fed raising rates] are going to the banks, with largest ones sucking up the biggest benefit.”  Leaving aside the need for the pejorative “sucking,” this is an odd construction.   A deposit is a liability for a bank.  (So, while Mr. Gandel states, “JPMorgan’s deposit income is $17.4 billion more than it was making annually in late 2016,” it is difficult to know what he means, as deposits are an expense.)

We think that he means something like the following (using his statistics and calculations):  BofA, JPM, Citi, and Wells have $5 trillion in deposits.  If we assume the federal funds rate is a reasonable proxy for what they can earn investing the proceeds of the deposits, their earnings have increased by $88 billion (annual rate) from 3 years ago.  This is likely an underestimate because many bank assets earn more than the fed funds rate.  At the same time, the interest that these banks pay to their depositors has gone up only $15 billion, based on his cited estimate from KBW.  So, on net, these four banks are making $73 billion more each year by investing their deposits than 3 years ago.

There Are Quite Logical Reasons Why Large Banks Might Offer Lower Rates than Small Ones

Not that there’s anything wrong with that….  Mr. Gandel views with suspicion that fact that the largest banks have been able to maintain lower deposit rates than small ones.  He reports a KBW estimate, which we assume to be correct, that the six largest deposit-holding banks pay 0.58 percent compared to 0.79 percent paid by small and midsized banks.  So, why would depositors be willing to accept two tenths of one percent in interest for banking at a large banks – so, $21 less per year on a $10,000 deposit.

Mr. Gandel offers three theories.  The first is technology, “Once a customer learns a bank’s mobile app, it may be difficult to switch to another just for a slightly higher return.”  But surely technology has increased, not decreased, competition for deposits.  Certainly, the emergence of Venmo/PayPal, Apple Pay, and Square seems to suggest that the public is not chained to its bank apps.  Venture capitalist are pouring billions into fintech firms on the assumption that banks can be disintermediated on mobile devices; they would presumably be surprised to hear that this is a dead end for them.

His second theory (of course) is that the largest banks were bailed out in the financial crisis, and therefore depositors currently prefer them to small banks – though, apparently, only to the tune of 21 basis points.  Of course, this overlooks what one might consider a key fact:  the government, in the form of the FDIC, insures all consumer deposits up to $250,000 per account.

Third, Mr. Gandel states that “the nation’s four biggest banks were allowed to get bigger in the financial crisis and have grown, albeit slowly, ever since.  That’s most likely given them even more pricing power than before.”  Since the crisis, concentration in the banking industry, measured by the Herfindahl index (the measure used by the DoJ) has trended down, not up.  Furthermore, Mr. Gandel cites no evidence for anti-competitive behavior in banking, which by the DoJ’s measure is among the least concentrated U.S. industries.  He also seems to think that the four largest banks don’t compete with each other, which would be news to every analyst and investor in the country.

So, why might a depositor might accept, on a $10,000 deposit, $21 less per year in interest from a large bank than a small one?   How about access to more branches and ATMs; broader product offerings; and more creative apps?  And then there is marketing (think Starbucks, Coca-Cola, Exxon).

So, in sum, deposit rates have not increased as fast as some other rates; that’s nothing new; and it may be temporary.  And large banks can offer lower deposit rates lower because they have more to offer depositors than interest.  Time to move along….


Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Bank Policy Institute or its membership, and are not intended to be, and should not be construed as, legal advice of any kind.