Just as other types of businesses set prices based on supply and demand, banks utilize a similar thought process when it comes to setting interest rates. The United States government also plays a big role in helping banks determine optimal rates for savings and checking accounts.
High interest rates on deposit products often attract customers to a bank, since higher rates allow them to earn more interest. So, if a bank is in need of additional deposits, they may increase the rates on their checking and savings accounts to bring in more customers. On the other hand, a bank may lower interest rates when they have a sufficient number of deposits and are more focused on decreasing their costs.
Another thing that factors into the rates that financial institutions are willing to offer on deposit accounts, is the rates they’re currently offering on loans. In general, a bank profits when the interest rates they charge on loans is greater than the interest rate they pay for deposits.
All of these competing priorities are largely effected by events taking place in the overall economy – such as the COVID-19 pandemic.
How the United States Government Impacts Interest Rates
The Federal Reserve plays a dramatic role in determining the interest rates banks are willing to offer their customers. The Federal Reserve meets regularly to set what is called the “Federal Funds Rate”. The Federal Funds Rate is the interest rate that banks are charged for overnight loans needed to meet reserve requirements. It directly impacts the interest rate that consumers are charged for borrowing money via credit cards, loans, and mortgages. Banks also typically use the Federal Funds Rate as a pricing benchmark when setting interest rates on deposit accounts.
Here’s a simple way to look at this: when interest rates on loans are low, interest paid out by banks will be too. A financial institution would have a hard time remaining profitable if it reduced lending rates in accordance with a drop in the Federal Funds Rate, but continued paying high interest rates on its checking and savings accounts.
Why Interest Rates Dropped in 2020
Shortly after the World Health Organization titled COVID-19 a global pandemic and the U.S. declared a national emergency in March 2020, the Federal Reserve made the decision to drop the Federal Funds Rate down to nearly zero. This was done in an effort to help stimulate the economy. For example, lower mortgage rates help improve the housing market. Likewise, lower rates on personal loans and home equity loans allow Americans to spend more money on things like cars and home improvements. Ensuring that Americans have money to spend helps to keep the national employment rate up.
So, given the correlation between loan and deposit rates, as banks started lowering the rates of their lending products in March 2020, yields on checking and savings accounts dropped as well. Although the Federal Funds Rate decrease was aimed at protecting the economy, it has adversely impacted the potential interest consumers can currently earn from their savings accounts. Prior to March 2020, the Federal Reserve had not lowered the Federal Funds Rate so drastically since December 2008, when it was lowered to near zero in response to the global financial crisis that was occurring at that time. Afterwards, the lowered rate remained in effect until December 2015.
Predictions for Deposit Rates in 2021
In January 2021, the Federal Reserve indicated that it will not recommend an interest rate increase anytime soon, and that the Federal Funds Rate will remain set to a range of 0% to 0.25%. Although this is not the best news for savings accounts, there is an upside. Many Americans are taking this opportunity to refinance their mortgages at lower rates, and unemployment trends continue to improve since March 2020. More people working means a faster economic recovery and an increased likelihood that the Federal Reserve will increase interest rates at some point within the next few years.
Lowering interest rates on loan products to stimulate the economy takes precedence during a worldwide crisis such as the Coronavirus pandemic. Savings interest rates will likely yield higher returns once the U.S. sees consistent economic recovery. In the meantime, if you’re interested in learning about other ways to potentially invest your money to meet your unique financial goals, visit our Investments page or schedule an appointment with one of our Investment Executives today.
High interest rates on deposit products often attract customers to a bank, since higher rates allow them to earn more interest. So, if a bank is in need of additional deposits, they may increase the rates on their checking and savings accounts to bring in more customers. On the other hand, a bank may lower interest rates when they have a sufficient number of deposits and are more focused on decreasing their costs.
Another thing that factors into the rates that financial institutions are willing to offer on deposit accounts, is the rates they’re currently offering on loans. In general, a bank profits when the interest rates they charge on loans is greater than the interest rate they pay for deposits.
All of these competing priorities are largely effected by events taking place in the overall economy – such as the COVID-19 pandemic.
How the United States Government Impacts Interest Rates
The Federal Reserve plays a dramatic role in determining the interest rates banks are willing to offer their customers. The Federal Reserve meets regularly to set what is called the “Federal Funds Rate”. The Federal Funds Rate is the interest rate that banks are charged for overnight loans needed to meet reserve requirements. It directly impacts the interest rate that consumers are charged for borrowing money via credit cards, loans, and mortgages. Banks also typically use the Federal Funds Rate as a pricing benchmark when setting interest rates on deposit accounts.
Here’s a simple way to look at this: when interest rates on loans are low, interest paid out by banks will be too. A financial institution would have a hard time remaining profitable if it reduced lending rates in accordance with a drop in the Federal Funds Rate, but continued paying high interest rates on its checking and savings accounts.
Why Interest Rates Dropped in 2020
Shortly after the World Health Organization titled COVID-19 a global pandemic and the U.S. declared a national emergency in March 2020, the Federal Reserve made the decision to drop the Federal Funds Rate down to nearly zero. This was done in an effort to help stimulate the economy. For example, lower mortgage rates help improve the housing market. Likewise, lower rates on personal loans and home equity loans allow Americans to spend more money on things like cars and home improvements. Ensuring that Americans have money to spend helps to keep the national employment rate up.
So, given the correlation between loan and deposit rates, as banks started lowering the rates of their lending products in March 2020, yields on checking and savings accounts dropped as well. Although the Federal Funds Rate decrease was aimed at protecting the economy, it has adversely impacted the potential interest consumers can currently earn from their savings accounts. Prior to March 2020, the Federal Reserve had not lowered the Federal Funds Rate so drastically since December 2008, when it was lowered to near zero in response to the global financial crisis that was occurring at that time. Afterwards, the lowered rate remained in effect until December 2015.
Predictions for Deposit Rates in 2021
In January 2021, the Federal Reserve indicated that it will not recommend an interest rate increase anytime soon, and that the Federal Funds Rate will remain set to a range of 0% to 0.25%. Although this is not the best news for savings accounts, there is an upside. Many Americans are taking this opportunity to refinance their mortgages at lower rates, and unemployment trends continue to improve since March 2020. More people working means a faster economic recovery and an increased likelihood that the Federal Reserve will increase interest rates at some point within the next few years.
Lowering interest rates on loan products to stimulate the economy takes precedence during a worldwide crisis such as the Coronavirus pandemic. Savings interest rates will likely yield higher returns once the U.S. sees consistent economic recovery. In the meantime, if you’re interested in learning about other ways to potentially invest your money to meet your unique financial goals, visit our Investments page or schedule an appointment with one of our Investment Executives today.