Banks’ deposit-rate challenge: How low can they go?

Register now

Deposits have surged to record levels this year, giving banks more than enough low-cost funds to meet current and future loan demand. But with the Federal Reserve recently cutting interest rates by a quarter of a point — and signaling that more cuts are coming — could the rapid deposit growth be coming to an end?

Bank CEOs have been telling investors and analysts that if the Fed continues to cut rates, they will follow suit and lower rates they are paying on deposits to minimize the hit to net interest margins.

The danger, of course, is that if banks cut rates too quickly or by too much, big depositors could move their money out of banks and into investments, such as stocks or real estate, that offer potentially higher returns, industry analysts and consultants say.

This does not appear to be happening yet — bank deposits hit all-time highs in three of the four weeks immediately following the Fed’s July 31 rate cut — and many banks are continuing to run deposit promotions.

The $9.3 billion-asset Capitol Federal Savings Bank in Topeka, Kan., recently offered a 2.35% rate for certificates of deposit with maturity dates between three months and eight years, Andrew Liesch, an analyst at Sandler O’Neill, wrote in a research note on the bank. Many other banks and credit unions also continue to offer CDs carrying rates over 2%, according to Bankrate.com.

Those favorable offers help explain why total bank deposits climbed by more than $350 billion, or nearly 3%, between the end of February and the end of August, to a record $12.9 trillion. When compared with a year earlier, total deposits at Aug. 30 were up 5.2%, according to Fed data.

Still, expect many banks to be far less aggressive in pursuing deposits if the Fed’s Open Market Committee moves to lower its benchmark rate by another quarter percentage point when it meets this week.

“A lot of banks have said that, once the Fed starts cutting rates, they’re going to cut deposit rates very quickly,” Kevin Reevey, an analyst at D.A. Davidson, said in an interview.

Neil Stanley, the CEO of the CorePoint in Omaha, Neb., who advises banks on pricing strategies, said banks need to be careful about cutting deposit rates too drastically because they risk losing not just deposits, but also other business opportunities.

“Over the long term, you’re losing the bank’s franchise value,” Stanley said. “If you don’t have a depositor, you can’t leverage that into more relationships.”

Other industry experts are less convinced, however, that customers will suddenly start moving their money into higher-yielding, but potentially riskier, investment vehicles as soon as banks start lowering rates.

“The safety of the [Federal Deposit Insurance Corp.] is still a big deal and people still remember the Great Recession,” said Steve Brown, the CEO of the $889 million-asset Pacific Coast Bankers’ Bancshares in Walnut Creek, Calif.

And even if deposits do begin to run off, banks can turn to other, relatively inexpensive funding sources to help meet loan demand.

At the Federal Home Loan Bank of Dallas, one category of advances is priced at between 2% and 2.1%, said Steve Otto, director of member sales. That’s less than what banks would pay to hold some municipal deposits, which generally carry rates of between 2.25% and 2.35%. When spreads reach that level, advances from the Federal Home Loan banks become more appealing for banks in urban markets, where deposit rates tend to be higher, he said.

“Generally, what happens when rates are reduced, it’s a positive for Federal Home Loan banks,” Otto said. “Our rates drop faster than deposit rates, which tend to lag the Fed’s rate cuts.”

And some banks will continue to aggressively pursue deposits, no matter what the rate environment is like. The largest banks, including the $374 billion-asset Capital One Financial in McLean, Va., have moved into new markets both by building new branches and expanding mobile and digital channels, and they view core deposit growth as essential to their business plans.

“We hope to continue to grow the balance sheet and we need funding for that,” Scott Blackley, Capital One’s chief financial officer, said on Sept. 10 at an investor conference.

For reprint and licensing requests for this article, click here.