The return of interest on your bank deposits
And why, even as mortgage rates shot up, it took this long
People who witnessed mortgage rates climb faster on a percentage basis than anyone has ever seen, from low 3-percent to 6-plus on a fixed deal, found themselves muttering a question:
Why has interest on my bank deposits stayed basically at zero? Shouldn’t that be going back up too?
The short answer is yes. The reasons why it didn’t are interesting, but it’s happening now, and anyone who has a little money in savings or checking accounts should pay attention.
No one on Cape Cod has a better vantage on all this than Robert “Bert” Talerman, president of the Cape Cod Five Cents Savings Bank. Bert has been at the Five for 16 years, leaving the former Cape Cod Bank & Trust soon after it was sold to off-Cape interests. Just in case anyone thinks of the Five as a sleepy little mom and pop bank, a few notes:
The Five has over $5 billion in assets -- that includes roughly 30 percent of all FDIC deposits on Cape Cod. When COVID struck, the Five alone handled $300 million in so-called “PPP” support loans (often gifts) funneled from the federal government. Moniker aside, the bank has grown and crossed Nantucket Sound to the islands and bridged the canal to Plymouth.
Alrighty then, back to “return on deposits”:
In the old days banks would do all kinds of things to encourage new deposits – anyone remember free toasters? But the main way they compete is rates, jockeying up a quarter or half percent to entice money away from competitors.
Why do it? Because, as Talerman puts it, “deposits are a bank’s raw material. Loans are your finished product.” Without deposits you have nothing to loan, no way to make money.
But in recent years, especially in response to COVID, banks became swamped with deposits:
“The government flooded the system at a greater rate than ever before, aiding businesses as well as individuals. My look at the charts says that the money supply in this country went up by more than $5 trillion” Yes, trillion.
Banks didn’t need to compete for deposits; in many cases they didn’t have enough good loan prospects to play out money they already had (a fact federal regulators don’t like). Yes, the local real estate market was going crazy, but “just think about how many of those purchases were accomplished without a mortgage,” adds Tallerman; cash deals. Plus the stock market was running up -- more to deposit.
Meanwhile, mortgage rates for the “finished product” hit historic lows. That’s where and how a bank makes money, but there has to be a margin between what it costs to manage the bank, and what the interest rate returns.
“With super low borrowing rates, no one was going to pay for deposits,” Bert concludes.
For many economists, a giant injection of cash means that the next shoe must drop: Inflation.
We could have a long discussion about whether that is really true, but no doubt inflation showed up and has been rampaging. That led the feds to raise short-term borrowing rates to “drain liquidity,” as Bert puts it, “and try to get inflation under control.”
As borrowing and mortgage rates rose again (and again, and again), a margin was recreated between what a lender can charge and what it costs to take care of business. Meanwhile, deposits are getting “sopped up,” coming out of accounts, put into play. Tallerman says that nationally and locally, total deposits were down six to seven percent in the fourth quarter of 2022.
So banks are starting to offer interest on deposits again. High-yield savings accounts are above three percent, certificates of deposit will guarantee four percent and more. They pretty much have to; a one-year Treasury Bill – super-safe, iron-clad -- is over four percent. With competition returning for deposits, banks need to respond.
It was a sluggish response for sure, but now depositors actually can shop around, and expect a little revenue in return for providing banks with working capital. That may not replace the bite taken by inflation, but it sure is better than seeing zero-percent return on monthly statements.
“In the most simple, basic terms,” says Talerman, “it breaks down to something we all have heard about forever: Supply and demand.”
Just don’t expect a free toaster.
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I just switched banks :)