A wave of remittances hits US banks as a sharp rise in interest rates after years of low borrowing costs creates more opportunities for savers – and new challenges for banks.
Until recently, software engineer Claire Long put all her money into a checking account she opened years ago as a college student. She had thousands of dollars built there despite the meager interest rate.
The prospect of earning 4% or more shook her from her complacency. This month she transferred $20,000 (£18,000) to another bank that offered a higher interest rate.
“I never paid attention to it. I just left my money in the account,” says the 26-year-old, who lives in Massachusetts and credits a personal finance podcast that alerted her to better options.
“I don’t want my money to just sit in one place. I want to make the best of it.”
Banks have been paying notoriously low interest rates on savings for years — something that hasn’t changed for many of the largest companies, even though the Federal Reserve has raised interest rates from near zero to over 4.75% in just one year.
But there are signs that the sharp rise is beginning to shake the status quo — and unsettling a financial system accustomed to relying on low-cost deposits as its main source of funding and profits.
“It’s a competitive market,” JPMorgan Chase chief financial officer Jeremy Barnum told investors on Friday, when the company reported that average deposits were down 8% from a year earlier.
About 30% of US bank customers transferred money from their main account to another bank in March, up from 27% a year earlier, according to a survey by consumer intelligence firm JD Power.
A third said they were switching to higher interest rates compared to a quarter earlier.
It’s a “slow climb,” says Paul McAdam, senior director of banking at JD Power. “But when you extrapolate that to millions of consumers, it makes a difference.”
Questions about how banks will deal with the change grew louder last month after the US was hit by the two biggest bank failures since the 2008 financial crisis.
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In the weeks following the collapse of Silicon Valley Bank and Signature Bank, billions of dollars in deposits changed hands, shaking a system accustomed to savings serving as a stable source of funding.
While that rush appears to have abated, many banks expect consumers to continue searching for the best deals as online banking makes switching funds easier than ever and rapid price inflation makes people unusually sensitive to an erosion of their savings .
“Consumers are more aware of how their returns compare to the loss in purchasing power,” said Greg McBride, chief financial analyst at Bankrate.com, which has tracked the interest rates offered to consumers for decades. “They took note of the higher yields at some banks and not others and shifted their savings accordingly.”
Many people, like Claire, are switching allegiances to open new high-yield or money market savings accounts, which according to data collected can pay interest rates of 3.5% or more, compared to the average interest rate of 0.24% on a traditional savings account bank rate.
Others are shifting their money away from banks entirely, opting for other types of investments, such as US Treasuries or money market funds, which can buy short-term government and corporate bonds with relatively low risk and offer interest rates in excess of 4.5%. but when interest rates were low, it hardly offered any advantages over a savings account.
The moves caused deposits held by banks in the United States to fall last year for the first time in decades, falling by more than $200 billion from a year earlier, according to Federal Reserve data in late December. Fitch expects deposits to fall by another $1.6 trillion this year.
“Banks and policymakers were prepared for deposit outflows in February. What is definitely the case now is that we are becoming increasingly uncertain whether the outflows will be larger than historical norms,” said Alexi Savov, professor of finance at New York University’s Stern School of Business.
The fall in deposits so far is still in line with what typically happens when interest rates rise.
Overall, the banking system continues to be stocked with cash, reflecting the unprecedented surge in deposits during the pandemic, as savings rates surged and government aid programs fattened people’s accounts.
However, there are many concerns about what lies ahead for the economy as the funds available for lending shrink.
Analysts say some banks, particularly the largest, can afford to lose some of their outsized deposits without a significant impact on profits or activity.
But Prof Savov says the outflows will put pressure on others, particularly smaller regional companies, which will squeeze profits and cause them to pull back on lending – with potentially severe repercussions for the local economy and some economic sectors, such as India. B. Commercial real estate, in which regional banks play a major role.
Recent bank failures have sharply accelerated outflows from these smaller players, he notes.
“It creates a much greater risk of a bumpy landing, possibly a recession,” says Prof Savov. “It’s just such a live ball.”
The growth of money market funds, whose holdings soared in the weeks following the banking crisis, has fueled the removal of money from the economy as the funds do not play a direct role in lending but have the ability to park their holdings with the US central bank, says Steven Kelly, senior research fellow at the Yale School of Management’s Financial Stability Program
Their growth also risks making the financial system more unstable, as the firms responsible for such investments are quick to flee at any sign of trouble, unlike ordinary depositors who can count on the government to keep accounts as high as $250,000 Guaranteed US dollars, he adds.
“An insured depositor might not run away at the first sign of bad news,” he says, but a money market fund is likely to “just disappear overnight.”
If the economy hits serious troubles, the US Federal Reserve is likely to cut interest rates — a scenario many investors see coming sooner after the banking panic.
That means that, as people like Claire seek more for their savings, the reallocation of deposits could also prove short-lived.
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