The days of dirt cheap deposit funding are slowly coming to an end.
Banks are preparing to pay up for deposits with the Federal Reserve Board poised to raise interest rates Wednesday by another 25 basis points. But it's unclear when, exactly, banks will pass along the benefit to consumers – or how large that benefit will be.
To the surprise of many analysts, the industry held off on raising deposit prices in 2016, even after the Fed raised rates late last year. Banks instead took advantage of higher rates on loans. Additionally, big banks, in particular, bulked up on cheap retail deposits to comply with new liquidity rules.
If the Fed continues to steadily raise rates in the months ahead, price competition for deposits is expected to intensify.
"In a rising rate environment, we are expecting that the industry is going to see lower deposits if they choose not to pay up for deposits," said Gerard Cassidy, an analyst with RBC Capital markets. "The easy days of garnering deposits and keeping them are probably behind us."
Banks will likely hold off on passing along the "next couple" of rate hikes to their clients, according to Cassidy.
That is because many banks are simply awash with funding and can afford to relinquish some deposits to competitors who pay higher rates.
As of Sept. 30 the loan-to-deposit ratio for the industry was about 71%, unchanged from a year earlier, but significantly lower than before the financial crisis, according to the Federal Deposit Insurance Corp. By comparison, the loan-to-deposit ratio was 94% a decade ago.
Analysts and investors were nearly united in their expectation for a rate hike Wednesday. But a surprise decision by the Fed to stand pat would not necessarily force banks to change their strategies.
"We've been conservative in terms of our deposit betas," Andy Cecere, the president and chief operating officer at the $448 billion-asset U.S. Bancorp, said at a recent industry conference. Competition for retail deposits over the past year was "not nearly" what the company had modeled.
Even a modest increase in deposit prices – on either the commercial or retail side of the business – would be significant.
Deposit rates have been flat across the industry over the past year, even after the Fed boosted rates 25 basis in December 2015.
The average rate on savings accounts with at least $1,000 was 0.13% in early December, unchanged from a year earlier and about eight basis points lower than December 2011, according to a recent report from Keefe, Bruyette and Woods.
The average rate on three-year CDs rose roughly one basis point from a year earlier, to 0.88%.
While consumers are starving for higher returns on their savings after several years of record-low rates, it's unlikely that they will notice the impact of the last week's rate hike, analysts said.
The Fed will likely have to increase rates by another 50 basis points before banks adjust their deposit pricing in a way that encourages consumers to start chasing higher yields.
"My view is that the industry is experiencing much greater overall customer inertia than we ever have," said Collyn Gilbert, an analyst with KBW. "It's a lazy consumer, and at the end of the day you're not getting that much benefit from moving to different banks."
Still, banks are closely monitoring consumer behavior. Advances in mobile and online banking have made it easier for retail customers to move funds between accounts.
Digital banks – such as GS Bank, the online savings bank from Goldman Sachs – have expanded rapidly since the last time interest rates were on the rise, just over a decade ago.
Online banks also pay higher rates than traditional banks with sprawling branch networks. Goldman Sachs and Synchrony Financial currently offering the highest rate on savings accounts in the country, at 1.05%, according to the KBW report.
"The hardest thing to do is predict what customers are going to do in a rising rate environment," Cassidy said.
In the year ahead, assuming the Fed continues to gradually raise rates, competition for deposits will likely vary across the country.
For instance, small and regional banks in the Northeast have balance sheets that are "underfunded" and in need of core deposits, Gilbert said. Many rely heavily on wholesale borrowings to fund their operations.
Regional lenders such as the $46 billion-asset New York Community Bancorp and the $6 billion-asset Dime Community Bancshares may move quickly to boost rates, Gilbert said. American Banker placed calls for comment to both banks Tuesday morning.
Additionally, rates on corporate deposits will likely increase at a faster clip than retail accounts, observers said.
"I think the institutional side will be a bit more sensitive, and the wholesale side will be a bit more sensitive, and we'll see an increase there for the next 50 basis points," Cecere said.
One dynamic to watch in the months ahead is whether corporate deposits decrease, even if rates move upward.
Higher interest rates typically coincide with improvements in the economy. Businesses are expected to draw down their liquidity before they tap their credit lines, as they look to invest in their businesses.
In the years following the financial crisis, businesses have built up the cash balances in their deposit accounts. How those clients respond to higher rates and a brighter economic outlook remains to be seen, Gilbert said.