A flood of transfers is slamming US banks as interest rates climb sharply after years of low borrowing costs, providing greater opportunities for savers – and new hurdles for banks.
Claire Long, a software engineer, kept all of her money in a bank account she opened as a university student years ago. Despite the low-interest rate, she allowed thousands of dollars to accumulate there.
The idea of earning 4% or more jolted her out of her slumber. She transferred $20,000 (£18,000) this month to a new bank with a better interest rate.
“I was never paying attention. “I just left my money in the account,” says the 26-year-old from Massachusetts, who attributes her better alternatives to a personal finance podcast.
“I don’t want my money sitting in one place.” “I intend to make the most of it.”
For years, banks have paid historically low rates on savings, which has yet to alter at many of the largest institutions, despite the US central bank raising its benchmark rate from near zero to more than 4.75% in only a year.
However, there are hints that the sudden rise is beginning to rock up the status quo, disturbing a financial industry that has been accustomed to depending on low-cost deposits as a primary source of capital and profitability.
“It’s a competitive market,” JPMorgan Chase’s chief financial officer, Jeremy Barnum, told investors on Friday, as the bank revealed that average deposits were down 8% year on year.
According to a poll by consumer intelligence company JD Power, almost 30% of US bank clients transferred money from their main account to another bank in March, up from 27% the year before.
A third indicated they were switching to higher rates, up from a quarter a year ago.
Paul McAdam, senior director of banking at JD Power, describes it as a “slow climb”. However, if you multiply this by millions of customers, it becomes significant.
Questions about how banks would deal with change arose last month when the United States experienced its two largest bank collapses since the 2008 financial crisis.
Billions of dollars in deposits changed hands in the weeks following the failures of Silicon Valley Bank and Signature Bank, jarring a system accustomed to savings functioning as a reliable source of funding.
While the rush appears to have abated, many banks predict that consumers will continue to look for the best deals, as online banking makes transferring cash easier than ever before and rapid price inflation makes people exceptionally sensitive to the erosion of the purchasing value of their savings.
“Consumers are more aware of how their returns stack up against the loss of buying power,” says Greg McBride, chief financial analyst at Bankrate.com, which has been tracking consumer interest rates for decades. “They have taken notice of the higher returns available at some banks but not others, and they have moved their savings accordingly.”
Many consumers, including Claire, are switching allegiances to create new high-yield or money market savings accounts, which may pay interest rates of 3.5% or more, compared to the 0.24% average interest rate on a typical savings account, according to Bankrate data.
Others are withdrawing their money from banks entirely, opting for other types of investments such as US government bonds or money market mutual funds, which buy relatively low-risk short-term government and corporate debt and can offer rates north of 4.5%, but provided little advantage over a savings account when interest rates were low.
Per Federal Reserve data, the changes caused deposits held by banks in the United States to decrease last year for the first time in decades, dropping more than $200 billion at the end of December from the previous year. Deposits are expected to fall by another $1.6 trillion this year, according to Fitch.
“Banks and policymakers were prepared for the deposit outflows that occurred throughout February.” “What we have now is increased uncertainty about whether outflows will be larger than historical norms,” says Alexi Savov, a finance professor at New York University’s Stern School of Business.
So far, the fall in deposits has been consistent with what happens when interest rates rise.
Overall, the financial sector is still awash with cash, owing to a record boom in deposits during the pandemic, as savings rates rose and government aid programs stuffed people’s accounts.
However, concerns about the economy’s future abound as lending money become scarce.
Analysts believe that some banks, particularly the largest, can afford to lose some of their large deposits without suffering a significant loss in earnings or activity.
Prof Savov, on the other hand, believes that the outflows will put pressure on others, particularly smaller regional firms, squeezing profits and prompting them to reduce lending, with potentially serious consequences for local economies and some business sectors, such as commercial real estate, where regional banks play an important role.
He notes that the recent bank failures accelerated outflows from the smaller players.
“It increases the risk of a rocky landing, and possibly a recession,” Prof Savov warns. “It’s just such a lively ball.”
To Steven Kelly, senior research associate at the Yale School of Management’s program on financial stability, the rise of money market funds, whose holdings increased in the weeks following the banking crisis despite the funds’ ability to park their holdings with the US central bank, has accelerated the removal of money from the economy. This is because the funds do not directly participate in lending but have the option to do so.
Their expansion also risks making the financial system more unstable, because the corporations in charge of such assets are fast to escape when difficulty arises, unlike ordinary depositors, who can rely on the government to guarantee accounts up to $250,000, he says.
“An insured depositor may not flee at the first sign of bad news,” he argues, but a money market fund may “just vanish overnight.”
If the economy faces major challenges, the US central bank is anticipated to decrease interest rates, which many investors believe will happen sooner than later following the bank panic.
That means that the reshuffling of deposits, as people like Claire seek more for their savings, may also be transitory.