What Is a Tiered-Rate Account?
A tiered-rate bank account is a checking or savings account that pays different rates of interest depending on the amount of funds held in the account.
- Tiered-rate accounts are bank accounts that offer escalating or "tiered" interest rates for different account sizes.
- They are used by banks to attract and retain customers.
- Together with account fees, maintaining deposits is essential for most banks’ profitability because it enables them to lend out depositors’ funds and generate higher rates of interest on their loans.
Understanding Tiered-Rate Accounts
Tiered-rate accounts are designed to attract larger depositors and to encourage existing depositors to save larger sums in their accounts. They accomplish this by offering different rates of interest for different levels of account savings.
For instance, a bank might offer interest rates of 0.25% for balance between $0 and $10,000, a second tier of 0.50% interest for balances between $10,000 and $100,000, and a third tier of 0.75% interest for balances above $100,000. Other banks might tether their interest rates to a reference or benchmark, offering larger spreads for the higher account balances.
A tiered-rate account may require a minimum balance to be opened as well as a minimum daily or monthly volume of transactions. For instance, a bank might offer a particularly high interest rate for accounts with frequent monthly transactions. In this situation, the bank is betting that it will generate enough fee revenues to offset the higher interest paid on the account.
Ultimately, however, the main source of business for commercial banks is the practice of lending out the money deposited by account holders. If default rates are low and the bank can earn a higher rate of interest on their loans than they pay to their customers, then the bank will be profitable.
In this context, banks need to balance between attracting customers on the one hand while maintaining their own profitability on the other. For this reason, it is very unlikely that the interest rates offered by a bank will be close to matching the interest rates charged on their loans—unless the fee schedule associated with that account is particularly expensive.
Real World Example of a Tiered-Rate Account
Emma is a longstanding customer at XYZ Financial, a national bank with several branches in her home city. One day, she receives a notice from XYZ indicating that the bank is offering a new bank account with a tiered interest rate structure.
Under the terms of this tiered-rate account, depositors are entitled to escalating interest rates on their deposits depending on the amount of money held in their account. Rather than providing fixed interest rates, however, XYZ offers variable rates calculated based on a spread against the prime interest rate.
For instance, for deposits between $10,000 and $50,000, XYZ offers a rate of prime plus 0.50%; for deposits between $50,000 and $100,000, the rate is prime plus 0.75%; for deposits between $100,000 and $500,000, the rate is prime plus 1.00%; and lastly, for deposits above $500,000, the rate is prime plus 1.25%.
Emma reasons correctly that this new incentive program is likely an effort by XYZ to attract and retain customers, particularly those with relatively large account balances. Moreover, she recognizes that the bank is likely able to lend out these deposits at higher rates of interest in order to maintain a positive net interest margin. Additional transaction fees and monthly charges add an additional source of revenue for the bank.