Interest rates are rising. So why aren't bank customers demanding higher interest on their deposits? This is the dilemma confronting banks.
For now, bankers are happy to keep deposit yields low, standing pat even as the Federal Reserve hikes short-term rates. No one is sure, though, how long customers will tolerate that.
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"Many bank management teams believe we could be one to two hikes away from an increase in retail" deposit rates, John McDonald, a bank analyst at Bernstein, wrote in a recent note. "At the same time however, we've never quite seen a cycle like this play out before, so it's tough to know for sure."
How banks prepare for any moves by depositors is important for their profits, especially given disappointing loan growth this year. Deposit rates will be top of mind for many investors when banks begin reporting earnings this Friday, because increases could maintain pressure on already-low net-interest margins.
Banks have been dealing with interest-rate cycles and depositors for decades, but a number of factors, both psychological and technological, make this time of rising rates different. A decade of near-zero rates, more competition from online firms, less loyalty from customers and new capital rules, among other factors, are making preparations more difficult.
"We've never really seen this movie before," Marianne Lake, chief financial officer of J.P.Morgan Chase & Co., told investors recently.
Of course, banks don't want to raise deposit rates until they have to. Though they tend to raise certain loan rates as soon as the Fed makes a move, they prefer to let deposit rates lag, bolstering profits.
And when they do raise rates, it is often because competition has forced them. "Nobody wants to be first," said Greg Carmichael, chief executive of Fifth Third Bancorp. "But nobody wants to lose deposits."
So far, the Fed has raised rates four times since December 2015, but banks haven't been under much pressure to raise deposit rates concurrently.
Bank of America is a case in point. Its cost for U.S. interest-bearing deposits in the first quarter was just 0.09% -- unchanged from the prior quarter and the lowest among its peers.
Talking with analysts recently, finance chief Paul Donofrio said it seemed unlikely that customers would leave the bank to chase rates because many had their primary checking accounts there.
Officers at some banks believe it will take another one or two Fed rate hikes before they have to start raising deposit rates. Others believe customers will start to demand higher deposit rates now that the Fed rate has crossed the visually important 1% threshold.
"The first Fed increase, people are like, 'Oh, it's still so small, who cares?' " said William H.W. Crawford IV, CEO of United Financial Bancorp Inc., a community bank based in Glastonbury, Conn. "By the fourth or fifth increase, people care."
Or at least they used to care. A complicating factor is that depositors haven't thought of bank accounts as income-producing instruments in nearly a decade, thanks to the Fed's near-zero interest-rate policies.
Given that, many customers have come to view banks in terms of the services they offer, such as mobile banking, rather than the rates they pay.
Another difference: Banks are awash in deposits. At the end of June, total deposits at U.S. commercial banks equaled $11.72 trillion, only slightly below an all-time high reached in May, according to Fed data.
What's more, loan growth has slowed this year, so the 4.7% average rate of deposit growth during the first half of 2017 was ahead of the 4.5% average rate of loan growth, Fed data show. Loans at U.S. commercial banks are equal to just 79% of total deposits, meaning even if banks saw some deposit outflows, many would have plenty of room to keep lending.
Fitch Ratings analysts said in a recent report that they expect banks will be able to keep deposit rates low throughout 2017, even if the Fed raises rates again, and won't meaningfully increase their rates until loan demand picks up.
Yet banks can't ignore depositors if they start to make moves. There are regulatory concerns, for example.
In certain tests related to the amount of liquid assets a bank has on hand, consumer deposits are more valuable than commercial deposits. That could prompt some banks to act quickly if depositors get itchy.
Meanwhile, technology has made it much easier for depositors to quickly shift funds and to use multiple banks.
Andrew Bain doesn't think much of the rates at J.P. Morgan Chase & Co., which generally pays customers with savings accounts from 0.01% to 0.08%. But he likes the bank's QuickPay system, which lets him pay for his children's daycare easily and without a fee.
So Mr. Bain, who works in corporate finance in Portland, Ore., found a workaround. He keeps enough money at J.P. Morgan to pay some bills and spreads the rest between a credit union and an online bank, both of which pay him more than 1%.
A number of online-focused banks, like Ally Financial Inc. and Synchrony Financial, are able to pay higher rates because they are less encumbered by brick-and-mortar expenses. An even newer competitor, Goldman Sachs Group Inc., has been driving rates higher to draw deposits to its new consumer bank. It currently offers 1.2% interest on online savings accounts.
All those factors combined raise the prospect that when consumers do decide to move, banks may be forced to raise rates at a faster pace than investors might be expecting.
Nelson Bonilla is part of that threat. His savings account at Synchrony pays about 1.15% interest. But Mr. Bonilla, a software developer in San Francisco, is on the lookout for institutions that might pay more.
Though he has already moved his savings account twice in recent years, he's open to being wooed away a third time. "I wouldn't hesitate," Mr. Bonilla says, "to switch again."
(END) Dow Jones Newswires
July 12, 2017 05:44 ET (09:44 GMT)