The Truth About Negative Deposit Rates

Is your bank account’s interest rate about to turn negative?

Some bankers warn it might! When the most recent Fed meeting minutes mentioned “the interest rate paid on excess reserves could be worth considering at some stage,” many jumped to the conclusion that when quantitative easing (QE) goes, the 0.25% payment goes—that without the alleged stimulus of bond purchases, the Fed will have to resort to smaller tricks to keep money moving. That prompted some bankers to claim they can’t afford to pay depositors if the Fed cuts them off. What the Fed will do is anyone’s guess—it’s the Fed. They might stop paying on excess reserves! But they don’t need to for growth to continue—nor would the move have much discernible impact on the flow of capital. Or your bank account—it’s highly unlikely all or even most banks start charging depositors.

First, a public service announcement: The hoopla over negative rates stems from one article, which quoted only anonymous bankers. If banks were truly prepared to start charging for deposit rates in the very near future, I’d expect at least one to be willing to go on the record. None are! That tells me they know customers will flee at the very thought, and they aren’t prepared to risk it. Which also tells me banks want to keep customers—and to keep customers, banks have to offer a competitive product. There are about 6,000 banks in the US. If your bank started charging you to hold your money, you could take your funds down the street to whichever bank still offers a positive return. Free markets and competition will save the day.

Second, some historical context: The Fed didn’t pay a dime on reserves before 2008, and banks managed to pay much higher deposit rates throughout much of the 20^th century. So it seems a bit odd for these anonymous bankers to claim they rely on the Fed’s payments to cover the cost of holding customers’ money. These days, costs are ultra-low. FDIC insurance fees range from 0.05% to 0.45%. Administrative costs are at rock-bottom, thanks to technology—you no longer need to make deposits and withdrawals in person, with a human being counting the money and writing the transaction in the ledger or entering it into a computer. ATMs, your phone and your computer can handle most transactions. Banks’ returns on lending and investment are more than enough to cover these low costs plus a small interest payment.

According to the FDIC, domestically licensed banks had about $487 billion in expenses last year, including $66 billion in interest payments (and including all salaries, bonuses and benefits). Total income was about $736 billion, including $487 billion in interest income. Of the $249 billion surplus, banks earmarked $58 billion for loan loss provisions, leaving pre-tax operating income of nearly $191 billion. Call me crazy, but I think it’s safe to say the paltry $3.8 billion earned on excess reserves didn’t tip the scale.

Our deposits aren’t what’s sitting at the Fed earning 0.25%. Our deposits are largely lent or invested, earning a higher return than the banks pay us. What’s parked at the Fed are all the credits banks have received through QE. The payment on these reserves doesn’t go to you and me—many banks let it accrue in their Fed accounts, where it helps them meet regulatory capital requirements.

The excess reserve payment doesn’t drive retail deposit rates—the market does, The Fed Funds target rate has some influence, but not nearly to the degree people assume—checking, savings and money market rates don’t track it. CDs do, but CDs (aka time deposits) represent a fraction of all bank deposits. Most deposit rates are determined by simple supply and demand—the rates banks decide they can offer to attract depositors without threatening net interest margins. They’re always competing for business. If some banks turn negative, others will still pay interest to steal their business.

So why are the banks so angst-ridden over the prospect of losing the small payment? Money is money—we hate losing it. The pain of losing money is about two and a half times as great as the joy of gaining it—bankers are people, and they’re as emotional as you and I. Plus, as mentioned above, many banks put the payment toward their regulatory capital requirements, which the Fed has hiked. If the Fed stops paying on reserves, it turns the screws that much harder. If I were a banker, I’d be a bit peeved. I might even anonymously spew hyperbolic threats to make the Fed change its mind.

This is also why banks probably won’t pull the entire $2.4 trillion (and counting) in excess reserves and lend it out if the payment stops. Banks don’t park cash because the Fed pays 0.25%. If that payment were an incentive, UK excess reserves would have been stratospheric back when the Bank of England paid 5.75% for a spell in 2007. They weren't—banks had better things to do with their funds. These days, banks park cash largely to meet regulatory requirements. The old required reserve ratio doesn’t mean much anymore—Basel III capital rules are what matter, and they mandate (among other things) that banks keep deep pools of high quality liquid assets to safeguard against a bank run. Basel’s requirements grow in the period ahead, something banks’ deposits at the Fed hedge against. Moreover, to the extent banks have capital in excess of Basel, the near-constant regulatory shifts in recent years likely make bankers a bit gun shy about lending and more apt to hoard cash. These are all much greater incentives to park cash at the Fed than a measly 0.25% return. If banks do pull some of their reserves in the event the Fed stops paying, they’ll likely go to US Treasurys or something similarly liquid and stable—not more loans.

Then again, the Fed doesn’t need to find clever ways to “keep stimulating” the economy once QE ends. QE’s end is stimulus! The Fed’s $85 billion in monthly bond purchases pulled down long-term interest rates, shrinking the spread between short and long rates. Banks borrow short and lend long—the spread is their potential operating profit. Shrink the spread, and banks don’t lend as much—credit is available to only the highest-quality borrowers.

Long rates have risen since Ben Bernanke first talked of tapering QE in May—markets are pricing in the end. They should rise further once QE winds down, widening the spread. Loans should become more plentiful and more profitable, money supply growth should accelerate and economic growth should follow. Loan demand should be fine—Fed surveys show demand has risen this year even as rates have gone up, and Bank of England surveys show the same in the UK. Demand is firm, supply is rising, and loan growth is ticking up. Heck, a rise in lending and profits might give banks more bandwidth to raise retail deposit rates!

Not that you should expect the Fed to see this—they’ve missed the obvious negative impacts of QE for five years now, and I wouldn’t be surprised if the foolishness at 20^th and Constitution persisted. But if the FOMC decides to replace the non-stimulus of QE with the non-stimulus of cutting excess reserves payments, you likely don’t need to worry about losing deposit interest. Banks still want your business, and they’ll find a way to earn it.