Why Your Savings Account Pays So Little: Banks Don’t Need Money
Banks are cutting lending as they brace for a recession. This is bad news for savers.
For most of the past two years, banks have been eager for loan demand to swell. Now that borrowers are on their doorstep, banks are tightening their lending standards. They do not need to attract funds, which is why the rates on deposits barely moved.
There is a common reproach that banks are only willing to extend credit to those who do not need it. And for much of the pandemic, that was true. Thanks to a mix of accommodative fiscal and monetary policy, households and businesses – on the whole – found themselves short of cash and had little need to borrow. With banks sitting on record levels of deposits, they had more than enough lending capacity, but demand for loans stagnated and even declined.
Fast forward to now, when persistently high inflation began to weigh on household and business cash piles, prompting them to borrow. The second quarter saw loan growth increase 4.1% sequentially, according to a recent report by Raymond James.
But banks, preparing for a possible recession and wanting to make sure they meet capital requirements set by the Fed, are tightening their lending standards, according to the Fed’s Lending Practices Survey. banks, published last week. . Some banks also said they were worried about weakening demand in secondary markets for these loans, which means banks should keep them on their balance sheets, according to the report.
Additionally, banks said they intended to continue tightening their standards for the second half of the year amid fears that borrowers would continue to be hampered by inflation and have difficulty repaying their loans. Banks are also worried that collateral values – which have risen during the pandemic – could deteriorate, giving them more reason to be cautious.
For bank investors, this is not good news. You can’t blame the banks for being cautious, but that’s also stifling growth. The caution comes amid two turbulent years in which the sector initially plunged due to the pandemic-induced economic shutdown. Investors hoped the Fed’s rate hike plans would lead to continued gains for the sector, as banks would earn more on the loans they make. But banks actually have to be willing to lend to get the net benefit of higher rates.
Savers, however, have more reason to be upset than bank investors. More than a decade of low interest rates means savers have had to get used to earning little or nothing on their deposit accounts. Rising interest rates were supposed to change that. So far this year, the Fed has raised rates by 225 basis points, or 2.25 percentage points. While borrowers have seen their financing costs increase, savers are not yet reaping the corresponding benefits.
It will likely take some time before deposit rates increase significantly. In most rate hike cycles, there is a lag between when banks revalue loans and when they revalue deposits, because loans are where banks make their money. Although deposit balances are shrinking in the face of inflation, they remain high relative to pre-pandemic levels. Therefore, banks see little incentive to raise deposit rates when they are not trying to secure contracts from other banks.
“With reserves still ample, there should be one more reason for banks not to compete too aggressively for short-term deposits – there is less room to use them to fund loans in circumstances,” Citigroup analyst Isfar Munir wrote in a recent note.
At the start of the Fed tightening cycle, the banking sector’s loan-to-deposit ratio was relatively low, standing at 75% in the first quarter of 2022, according to a recent report by Keefe, Bruyette & Woods. This is 15 percentage points lower than the loan-to-deposit ratio at the start of the 2016-2018 tightening cycle.
“All else equal, this provides greater flexibility for banks to delay deposit repricing,” wrote KBW analyst Christopher McGratty.
All in all, the rest of the year will be frustrating for bank investors but infuriating for savers.
Write to Carleton English at [email protected]