Old-Time Passbook Deposits No Bargain for Banks Now

Sharply lower interest rates are causing fundamental changes in one of banking's most venerable products -- the passbook savings account.

Long cherished by banks as an especially cheap source of funds, passbook accounts aren't much of a bargain anymore.

Spread Has Narrowed

In recent years, these deposits were as much as 4.75 percentage points cheaper than federal funds, a key yardstick for the cost of raising funds.

But because banks have been reluctant to reduce already-low passbook rates, that spread has narrowed sharply in recent weeks. It now stands at a meager 44 basis points.

What's more, the dramatic rate drop could affect the stability of passbook accounts, some bankers said.

Volatility Rises

That's because, as the gap narrows between returns on passbook accounts and mutual funds, more cash could flow into banks. In turn, deposits could flow out just as quickly when rates on mutual funds rise.

"The banks who thought they had a stable source of funding will see those deposits go to the next highest bidder," said Kevin Hurley, a vice president at Manufacturers Hanover Corp.

That would undermine passbook savings' stability -- a factor as important to the funding officer as their relative cheapness.

Historically Stable Customers

Those accounts make up about 10% of bank deposits, according to Federal Reserve figures. (Checking deposits comprise 27% of the total; money market accounts, 17%; and certificates of deposit, 46%.)

Passbook depositors, typically longstanding bank customers, have been a welcome contrast to rate-sensitive institutional investors, who tend to jump from bank to bank for a few basis points of interest.

"It's stable underlying funding," said Garland Hagen, executive vice president at Crestar Financial Corp. Crestar has bought more than $1 billion in deposits from failed thrifts in the past year.

Slow-Moving Rates

Just as core deposit rates fall more slowly than other rates, they likewise take longer to rise, Mr. Hagen said.

Moreover, every retail deposit account represents a customer who can be sold other bank products. "When you buy core deposits, you buy banking customers," he said. "When you buy fed funds, all you do is buy fed funds."

With widespread predictions that short-term rates will fall even further in coming months, the rates paid on savings accounts could soon exceed banks' cost of funds -- especially when servicing expenses and deposit-insurance premiums are factored in.

Fear of |Sticker Shock'

In theory, banks could simply reduce the rates they pay. But they fear that might wake up depositors and spur them to move their funds elsewhere. Because passbook rates change infrequently, the thinking goes, depositors are more likely to notice changes.

"You don't want to give customers sticker shock," said one banker.

Citicorp, for one, just cut the rate it pays on its interest-bearing checking account to a mere 2%, but the rate on its passbook savings account has been 4.5% for months.

Consumer Groups Unhappy

Banks also risk a backlash when savings rates are reduced. "We've been screaming about it," said Peggy Miller, banking representative at the Consumer Federation of America. Consumers "aren't getting any of the benefits of lower rates," such as a sharp drop in the prime lending rate, to which many consumer loan rates are tied. "It's absolutely unjust."

New deposits could be attracted if rates continue to drop overall but banks maintain passbook rates.

BankAmerica Corp., for one, expects its base of passbook savings accounts to grow in 1992, according to James Westfall, a vice president.

A Two-Way Street

It's not inconceivable that mutual fund rates could drop below those for passbook accounts.

Said one banker: "If you keep [passbook accounts] at current rates, then all your market-sensitive money will start to move into the savings account."

In effect, passbook savers as a group could turn into a much more rate-sensitive constituency -- an expensive change, if banks hope to keep them and interest rates later turn up.

"When rates start to turn up, it's going to make for an interesting time for some retail banks," said one banker.

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