Market Rates Insight has been tracking deposit rates for more than 25 years, and its unusual to see the kind of stagnation in short-term interest rates that we have witnessed in the past year or more. The Fed continues to maintain interest rates at near zero in hopes of stimulating investment and jump-starting economic growth. As was pointed out recently in American Banker:

“Bernanke's rationale, which reflects the prevailing view among economists, policymakers and Fed governors, is that near-zero rates provide economic stimulus because higher asset prices filter down to increased consumption, and therefore investment and job creation.

“But it's not working that way. In fact, the anemic nature of the recovery compared with those following previous recessions demonstrates the need for an urgent re-examination of the Fed's policy.”

According to the argument offered by author John Michaelson, co-founder of Imperium Partners Group LLC, an investment manager in New York, the continued near-zero interest rate damages the economy in a number of ways:

1. The wealthy are getting wealthier, by as much as $600 billion per year. According to Michaelson, the low interest rates are supposed to increase lending and stimulate job growth, but instead the Fed’s wealth transfers are rewarding shareholders and executives in the financial sector.

2. With little or no return on savings, added pressure is being placed on pension plans, retirement accounts, foundations, trusts, and other long-term investments. The result is a slower recovery since it is delaying a restoration of investor confidence.

3. There is no incentive for the job-producing middle-market companies and small businesses since, by producing a steep yield curve on government and high-quality credits, there is no incentive to lend money to smaller businesses. Why risk lending to smaller business when you can earn easy money lending to the bigger guys?

“In human terms, the Fed's policy means dairy farmers in Iowa are forgoing equipment purchases to save for retirement, charities in Manhattan are reducing services as foundations cut grants, and local governments are laying off teachers to cover pension plan deficits.”

Michaelson bases his argument on what happened in Japan in 1990, when the credit bubble burst and the Japanese brought its interest rate down to 0.25 percent. The pundits say the following decade of stagnation is the result of not bringing rates down fast enough. However, Michaelson argues that it promoted the same “anemic private consumption,” which led to failed stimulus programs and government debt.

Raising interest short-term rates will reverse the trend toward wealth accumulation and provide an incentive to start investing again, which will stimulate the economy. Raising interest rates will give banks an incentive to seek out investments closer to home that would create new jobs, and help restore confidence in their depositors. Or so the argument goes.

What’s your opinion?

According to Market Rates Insight’s weekly National Pricing Indicator report, despite the overall decrease in the national average deposit APY in the first four months of 2011, some states are showing an increase in the average deposit rates. Although these states show the highest increase, they do not necessarily offer the highest rates overall.

• Rates of CDs have increased by 18 bps from January to April of 2011 in Alaska; 8 bps in Rhode Island; 7 bps in Kentucky; 3 bps in Arizona and 2 bps in South Dakota (Figure 1).
• Rates of MM have increased by 17 bps from January to April of 2011 in Kentucky, 8 bps in Delaware; 8 bps in Kansas; 5 bps in Alaska and 4 bps in West Virginia (Figure 2).
• Rates of Savings have increased by 23 bps from January to April of 2011 in New York, and 1 bpt each in South Carolina, Virginia, Alabama, and Maine (Figure 3).
• Rates of Checking have increased by 2 bps from January to April of 2011 in Kansas, and 2 bps each in Alaska, Hawaii and Illinois (Figure 4).
• Alaska is showing more deposit-product rate increases than any other state, with increases in CDs, MM and Checking accounts.

In this week’s National Pricing Indicator report, new research shows the gap between the average Internet rate (pure cyber institutions) and the national average deposit rates at traditional institutions diminished over the past four years. In March of 2007, the national average rate of Internet deposits was 3.50%, compared to the branch average rate of 3.16%. By March 2011, the national average Internet rate was 0.58%, compared to the branch average rate of 0.64%.

Although the national average deposit rate decreased in both, Internet and branch institutions, there were variances in the level of APY decreases between the two. The greatest APY decrease in Internet APY occurred in one-year CD, which dropped  from 5.09% in March 2007 to 0.69 in March 2011 - a drop of 4.40%. The smallest decline in Internet rates occurred in high-yield checking, which dropped from an average of 1.13% in March 2007 to 0.43 in March 2011 - a drop of 0.70% (Figure 1).

The greatest APY decrease in branch-average rate also occurred in the one-year CD, which dropped from an average of 4.58% in March 2007 to 0.55% in March 2011- a decrease of 4.03%. The smallest decline in branch-average rate also occurred in high-yield checking, which dropped from an average of 2.28% in March 2007 to 0.32% in March 2011 - a decrease of 1.96% (Figure 2).

The trend identified in Market Rates Insight’s National Pricing Indicator report this week shows that banks and credit unions are working to secure their deposits by shying away from “hot money” accounts that can easily be moved to another institution follow a higher rate, and instead are focusing on relationship banking packages that force depositors to establish multiple accounts. Banks are increasing the relative premium paid for relationship products, and increasing the number of relationship products they offer.

According to the latest research, in January 2010 the average premium paid on relationship accounts was 10 percent over the rate of the basic account. In January 2011, the average premium increased to 16 percent. the increase in the relative premium for relationship accounts compared to basic accounts is mostly due to the decrease in the rate for basic accounts over the last year. By comparison, the relationship accounts did not decline as much (see Figure 1).

There also was an increase in the number of relationship products offered to consumers. In January 2010, 28 percent of available deposit products were relationship products. By January 2011, that number increased to 31 percent – up 3 percent in 12 months (see Figure 2).

Note that deposits from relationship accounts are more steady and predictable, and are more likely to product non-interest income as well.

According to the latest National Pricing Indicator report, the deposit balance mix has shifted from non-jumbo CDs to liquid accounts. Balance mix is the relative percentage of each product balance out of total deposits (i.e. 100 percent). Note that the combined percentage of the liquid and term accounts in this analysis don’t add up to 100 percent since some deposit products like IRAs are not included.

• In the last two years, 2009 and 2010, savings accounts gained the most in percentage relative to total deposits showing an increase of 1.4 percent.
• Checking accounts gained the least with an increase of 0.5 percent.
• Money market accounts showed an increase of 1.4 percent relative to all other deposit productss over the last two years (see Figure 1).

The findings for term accounts were mixed. In the last two years, balances mix of CDs of up to $100,000 decreased relative to total deposits by 1.6 percent. However, balances mix of jumbo CDs over $100,000 increased by 1.5 percent during the same period (see Figure 2).

These findings reveal that in cases where there is no significant differentiation in yield, such as
between money markets and non-jumbo CDs, consumers will normally opt not to keep their money liquid. Yet, in cases of jumbo CDs that offers higher rates, the incentive to lock money away in favor of a higher yield is greater.

This week’s National Pricing Indicator report revealed that interest rate premiums, which are used to attract new deposit money, are shrinking relative to the base rate offered on deposits.

In the beginning of 2010, the average premium on deposits was almost double the base rate at 97 percent. By the end of 2010, the average premium shrank to 81 percent of the base rate offered on deposits (see Figure 1).

Among term accounts, the 48-month CD experienced the biggest relative drop in premiums, plummeting from 82 bps in January of 2010 to 25 bps in December of 2010. The only increase in premium during 2010 was for the 60-month CD, which increased from an average of 77 bps in January to 79 bps in December of 2010 (see Figure 2).

Among the liquid accounts, checking accounts experienced the greatest decline in premiums relative to the base rate. The average premium on checking accounts dropped from 259 bps in January of 2010 to 73 bps in December of 2010. Premiums on money market accounts were the most stable. They dropped only 17 bps from 59 bps in January to 48 bps in December of 2010 (see Figure 3).

According to Dr. Dan Geller who compiled the research, there are two implications to be derived from these findings: 1) The supply of deposits well exceeds the demand for lending, and 2) The pressure on Net
Interest Margins is forcing banks and credit unions to reduce their most expensive rates.

In today’s American Banker online e-zine, an article entitled “Banks Learn to Cope with Flood of Deposits” cited our November 29 National Pricing Indicator report, which revealed that depositors continue to stash their cash in deposit accounts, despite the fact that deposit yields are at their lowest rates in recent history:

“Data gathered by the deposit research firm Market Rates Insight shows that total deposits increased by a full trillion dollars in the 36 months preceding October, despite the steady plunge of rates paid in that same time frame. Historically considered to be elastic in supply, the quantity of deposits now entering the banking system appears to be insensitive to interest rates that banks offer.

“A consequence of retail banking customers' demand for safety above all else, the trend is complicating banks' efforts to match their assets with funding — and raising questions about how low even non-inflation-adjusted rates can go. If customers come to view deposit accounts as a simple insurance product, suggested Dan Geller, Market Rates Insight executive vice president, they might even pay to put their money there.”

As the article reports, banking industry profits have been turned on their head. Where deposit profits used to be the bread-and-butter and lending the commodity item, profit sources are now reversed and banks need to focus on lending, because they aren’t getting the yield from deposits.

As Fiaz Sindhu of Accenture’s North American banking practice notes, banks that invest in price analytics to keep rates in line with declining yields are in a better position to remain competitive. Sindhu also notes that deposit products are also useful for attracting new customers and prospects who might buy other more profitable products, like brokerage services. Apparently executives at Wells Fargo and other institutions agree:

“ ‘While you could argue that your free deposits aren't so valuable because where are you going to invest them today, I think that's a very myopic and short-term way of looking at it,’ said Wells Fargo & Co. Chief Executive John Stumpf . Wells is happy to bring in the money in the hope that it can sell a person ‘six products, seven, eight’ if they open up a new account.”

The challenge to bankers will be to apply the right rate research to make sure their deposit rates are competitive, and attract new business in order to upsell, cross-sell, and bring in new customers today. Investing in precise rate research and rate analytics from companies like Market Rates Insight is one way to stay ahead. With the right market intelligence, you can optimize your products today for maximum yield and to build a customer base ready to sustain future profits.

Market watchers are predicting a rise in inflation. Last week’s auction of of five-year Treasury Inflation-Protected Securities (TIPS) drew a negative yield of 0.55 percent for the first time in history. This is a signal that the market is hedging against inflation.

However, higher inflation does not necessarily signal higher deposit rates for financial products. According to this week’s National Pricing Indicator report from Market Rates Insight:

“The inflation rate, by itself, is not a strong predictor of deposit rates - the Fed effective rate is, which means that even if the inflation rate increases, deposit rates may not increase if the Fed effective rate does not increase in response to a higher inflation rate.”

By way of example, the report notes that in June 2002, the national inflation rate hit a low of 1.07 percent, climbing to a peak of 3.02 percent in March 2003. But during that same time period, the Fed effective rate decreased from 1.75 percent to 1.50 percent. The result was a decrease in the average deposit rate from 3.23 percent to 2.34 percent, despite the increase in the rate of inflation (see Figure 1).

By contrast, the national inflation rate hit a low of 1.69 percent in February 2004, climbing to a peak of 4.32 percent in June 2006. During the same period, the Fed effective rate gradually increased from 1.01 percent in February 2004 to 4.99percent in June 2006, pushing the national average deposit rate up from 2.06% to 4.36 percent for the same period (see Figure 2).

With rates on deposit accounts continuing to decline, could the return on bank accounts actually reach 0 percent? Could consumer perception change to the point where depositors start looking at FDIC-insured deposits as something worth paying for, like life insurance? Both these premises aren’t so far-fetched, and they could even become eventualities if current market conditions continue according to Dan Geller, Executive Vice President of Market Rates Insight. In an article entitled “Return of Deposits or Return on Deposits?” posted to BAI: Banking Strategies today, Dan writes:

“Deposit rates have been on the decline since late 2006, when the national average annual percentage yield (APY) peaked at 4.37%. Today, the national average APY for deposits stands at 0.85%, which represents a decrease of 352 basis points (bps) in 48 months, or an average decline of 7 bps per month, which is a trend that continues as we speak. Since most economists do not project any major improvement in the economy over the next 12 months – in terms of employment, housing and gross domestic product – it is possible that the national average APY for deposits will reach zero by this time next year. We are already seeing some of the signs that may lead in that direction.”

Dan points to a precedent – the Riksbank in Sweden dropped its fund rate to -0.25 percent to promote bank liquidity. This experiment is something that other central banks, like the Fed, are watching with interest.

In a world where banks yield no return for your money, will consumers be ready to pay to secure their deposits? Mortgage rates continue to decline, putting more pressure on lenders. With pressure to keep the Net Interest Margin (NIM) around 3 percent, if mortgage rates decline to 2.75 percent it could drive the APY for deposits into negative territory. The end result could be a call for consumers to pay to insure their deposits in FDIC-insured account, rather than looking for a return on their deposits. If this seems unprecedented, these are unusual times. We are all dancing to deposit rate limbo and these day’s it’s all about how low can you go!

An article in today’s online edition of American Banker quotes a recent National Pricing Indicator report from Market Rates Insight  that shows that banks are continuing to offer low-rate, short-term CDs despite the fact customers don’t seem to want them.

As the news report points out, deposits in short-term CDs have declined 12 percent in 2010 to $675 billion, even though banks and credit unions have introduced 26 percent more CD products:

“The problem is, most banks are not sweetening the deal.

“Though the highest-yielding short-term CD is paying 1.82% on a 12-month product, the average short-term CD pays just 60 basis points. Compare that with long-term CDs (36 months or more), which are paying an average of 1.41%. That is hardly a king's ransom, but at least deposits in these products are up by 4%, or $4 billion, to $109 billion….

“By comparison, the single one-year fixed annuity that Beacon Research tracks, the Liberty Bankers One, which is comparable to a one-year CD because both its surrender charge and rate term are 12 months, currently pays 1.2%.”

Quoting Market Rates Insight’s Executive Vice President Dan Geller, "Banks should be more attuned to what customers want and how they're voting with their dollars."