As interest rates rise, banks are facing pressure to change their longstanding practice of paying depositors practically nothing.
- Despite the Fed's benchmark interest rate having risen 5 percentage points since March 2022, banks have been slow to offer higher interest rates to depositors.
- Banks are able to keep rates low because many customers do not shop around for better deals.
- Increasing competition on rates, as well as recent bank failures, have spurred banks to offer more high-yield options and could encourage them to raise interest rates on more kinds of accounts.
The Federal Reserve raised its benchmark fed funds rate for the 10th time in a little over a year on Wednesday, bringing its benchmark fed funds rate to a range of 5% to 5.25%. As of Wednesday, banks could collect 4.82% interest on the funds they parked at the central bank. Banks have raised their prime rates, at which they lend money, in lockstep with the Fed.
Meanwhile, banks passed a pittance of that on to their depositors, offering on average just 0.39% interest on savings accounts, according to data from the Federal Deposit Insurance Corporation.
That difference in rates can mean significant amounts of money gained or lost for savers. A savings account with a balance of $26,000—the median value of a typical U.S. household’s financial assets as of 2019 according to Federal Reserve data—would grow to $27,034 over 10 years at the average savings account interest rate of 0.39%. That figure would be $42,061 if the account paid 4.82% over that same time span.
How have banks gotten away with being so stingy with their interest rates, anyway, and how much longer can it last?
One major factor holding rates down is customer loyalty, said Eugenio J. Alemán, chief economist at Raymond James.
“It will take a very, very large increase in rates to make people really change banks,” he said. “For many years, they’ve worked with this assumption that Americans will not change banks….People either don't know or they are too lazy to go and open up an account in a different bank.”
That may help explain why average rates have stayed low despite some banks—especially online ones—offering much higher rates in an effort to lure customers.
Research by economists at the Federal Reserve Bank of New York backs up the impression that banks have been slow to raise the interest rates they offer on savings accounts and certificates of deposit even when the Fed is in hiking mode.
However, banks have a growing number of reasons to change their ways.
For one, the fate of Silicon Valley Bank, which imploded in March in a classic bank run when depositors fled en masse, serves as a warning that banks should be raising rates to hold on to their deposits, Alemán said. The higher rates get, the more competition will force banks to either raise rates or lose everything, Alemán said.
Interest rate hikes and banking turmoil has shifted customers' behavior some, and prompted banks to offer more high-yield savings accounts, said Jennifer White, senior director of banking and payments intelligence at JD Power.
"As interest rates rose, shopping increased as did high-yield account (HYA) openings. When banks could offer their existing customers a HYA option, many customers stayed loyal," she wrote in an email. "Even in the months since HYAs started booming or the weeks since the bank failures began, customers remain loyal to their primary bank in high proportions. They may shift deposits to secondary institutions, but attrition rates from their primary relationship are not increasing significantly."
A survey by JD Power in April showed the share of bank customers moving their money had risen slightly: 29% of bank customers moved on average 39% of their deposits to a secondary account in the previous 90 days. That's compared to 27% having done so in March 2022. Among those who moved money, 29% said they were chasing higher interest rates, up from 25% in March 2022, according to the online poll of 4,000 U.S. adults.
There’s also pressure coming from the government and activists. In November, Senator Jack Reed, a Rhode Island Democrat, sent letters to major banks demanding them to 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 cutting banks out of the retail saving business.
There are signs the tide is turning, at least for some depositors. Alemán, who is holding money from selling his house last year in a savings account, noticed the amount of monthly interest it was generating went from $8 to $800 over the three months ending in December.
“My guess is that they are starting to increase interest rates for those who have very large amounts of money,” he said. “Basically, they are discriminating because of the size of a savings account. But I think that we should start seeing very soon an increase in savings rates across the banking sector.”