How Savings Account Interest Rates Are Determined

At a basic economic level, the interest rate set on savings account deposits is determined by the relationship between how much banks value receiving extra deposits and how much savers value the services of a savings account. Those valuations are manipulated by how governments and central banks target interest rates in the economy.

Supply and Demand of Savings Accounts

Most savings accounts are liquid accounts that protect the value of principal kept with the bank. Consumers value savings accounts for their safety and flexibility. Banks offer them as a means of enticing depositors to provide extra cash so bankers can make loans.

When banks want extra deposits, they can raise the interest rate offered on savings accounts to attract extra cash. If they want to decrease bank debits, they can lower interest rates. It is important that banks do not offer more interest for savings accounts than can be charged on loans or earned on other investments.

The interest rates on savings accounts are endogenously dependent on the rates offered on other savings destinations such as bonds and money market accounts. Each saver tries to find the best balance of security and return based on his preferences.

Government Influence on Interest Rates

Suppose the Federal Reserve purchases a lot of new U.S. Treasuries. This bids up the price of Treasuries and lowers yields. Banks can subsequently lower the rate offered on savings accounts and probably must lower the interest rate charged on loans, too. There are many reasons for this, including the fact that banks tend to invest in Treasuries for safe returns.

Remember that savings account rates have to compete with the other returns available in the market. When interest rates decline, savings account rates also drop. When interest rates rise, savings account rates are bid up. Generally speaking, central banks and governments support low-interest rate environments. This artificially pushes down the rates earned everywhere else in the economy.

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