Rates on Basic Savings Accounts Falling Below Longtime 5% Floor

Basic savings accounts, which had been paying consumers a relatively constant 5% or more since the 1970s, are falling prey to the widespread decline in interest rates.

Some of the nation's leading retail banks, including Citibank, have recently lowered savings rates to well below 5%. Barnett Banks Inc. in Florida is paying 4% on passbook accounts and only 3.75% on NOW checking accounts.

The trend may encourage consumers to move funds into higher-yielding certificates of deposit or money market accounts. Rates on those accounts had been cut previously, in some cases close to passbook levels.

A Salutary Effect

But to the extent the funds stay in savings accounts, the trend will have a salutary effect on the industry's costs of funds. Savings deposits comprise 25% of the $2.4 trillion in total commercial bank deposits.

The national average rates stood at 5.01% on passbook accounts and 5.09% on statement accounts as of April 1, when the Bank Rate Monitor completed its survey of basic savings accounts in 10 major markets. Two years earlier, passbook accounts paid an average 5.17% and statement accounts 5.22%, according to the North Palm Beach, Fla., research firm.

Rate-Cutting Leaders

But the average rates in such major markets as Los Angeles, San Francisco, and Philadelphia were already below 5% by April of this year; and market observers say the rest of the country is following suit.

"I think it's a long-term phenomenon," said Thomas Brown, an analyst at Donaldson, Lufkin & Jenrette. "The spreads between deposit rates and lending rates are going to be wider."

Some of the consumer savings rates currently being quoted seem a throwback to an earlier era when rates were regulated, stayed low, and rarely changed.

Statement Savings Lose Appeal

Citibank in New York, which paid 5.5% on statement savings - as an inducement to passbook holders, who were paid only 4.5% - dropped the statement rate to 5% on May 1 and to 4.5% on July 1. Citibank had not cut the statement rate since the automated accounts were created in the 1970s.

Manufacturers Hanover Trust Co. in New York has not dropped below 5%, but it reduced its passbook rate in June by 25 basis points to 5%. Its statement savings rate will drop July 15 to 5% from 5.5%.

Such accounts represent only a portion of banks' funding. But the lower rates will nonetheless save money and boost net interest margins - a plus while profitable lending is difficult.

Sluggish loan demand and an inflow of deposits into the banking system are both inducing banks to lower savings rates. With lending outlets scarce, they are opting to risk losing some deposit accounts in order to pay less on those that remain.

The generally lower interest rates are also contributing to the savings-rate declines, because banks do not have to pay as much for other types of funding.

"The value of a deposit is its replacement costs - what it would cost a bank to replace it with interbank funds," said Raphael Soifer, an analyst at Brown Brothers Harriman & Co. "Interbank rates are coming down, and at some point banks have to reflect that in the rates they pay depositors."

The increase in deposit insurance premiums is also a factor. As banks pay more for insurance, lower rates help keep their costs in line.

"With the FDIC insurance rate going up, banks are trying to make consumers pay for it," said David Berry, an analyst at Keefe, Bruyette & Woods.

Fewer Healthy Competitors

Another factor in the lowering of rates is consolidation. Healthy institutions are absorbing deposits from failed savings and loans, and mergers are reducing the number of competitors for deposits.

BankAmerica Corp., for example, recently purchased $6 billion in deposits in Arizona, and acquired just $200 million in loans at the same time, Mr. Brown of Donaldson, Lufkin & Jenrette said. He does not expect BankAmerica will ever lend as much in Arizona as it holds in deposits.

"The industry is becoming awash in deposits," Mr. Brown said. "As a result, if they lose the last incremental dollar, so be it to improve profitability."

Fed funds were trading at 6.125% Monday afternoon, well above the apparent target rate of 5.75%. Traders said the Federal Reserve apparently failed to add sufficient reserves to the system over the long holiday weekend.

"Whenever they get behind, they can never immediately turn around and correct the mistake," one fed funds broker said.

The bank bond market was quiet as investors awaited banks' announcements of their second-quarter results. The gap was wide between bid and offered prices, traders said.

"I'd be shocked to see any new offerings for the next couple of weeks until we get earnings behind us," said one capital markets specialist. "Nobody wants to step in front of this train."

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