The Retired Investor: Secret Behind Low Interest-Bearing Checking Accounts

The bankruptcies and financial contagion among regional banks have spotlighted a question point among many consumers. Why is it that banks are getting away with paying zero interest on billions of dollars in checking accounts?

 

The interest on savings accounts isn't much better. In a recent survey by Bankrate, a consumer financial services company, nearly 80 percent of U. S. savers say they earn less than 3 percent in their savings accounts. Today, with interest rates yielding between 4-5 percent (and inflation topping 7 percent), a mere 7 percent of Americans are getting the prevailing rates. What is worse, only a relative few are taking advantage of the opportunity to earn money on their money.  

 

The origin of this financial disconnect hearkens back to 1980. Before that date, banks were not allowed to pay interest on checking accounts. Non-bank institutions, such as thrifts and savings and loans, could not even offer checking accounts. The amount of interest banks were allowed to pay on deposits was limited by laws that were in effect since the Great Depression. These regulations were thought to preserve the health of the banking system at a time when interest rates were set by the Federal Reserve Bank.

 

The late 1970s revealed how detrimental this arrangement was for the consumer. It was a period of both double-digit inflation and double-digit interest rates. Savers were getting zero on their checking accounts, and only a regulated 5.25 percent on savings accounts. To lock in higher interest, beleaguered consumers bailed out of banks and moved their savings into unregulated entities such as mutual funds that were offering twice the rate of interest.

 

This all changed when Congress, during the Carter administration, passed the Depository Institutions Deregulation and Monetary Control Act in 1980. The legislation deregulated institutions that accepted deposits and phased out restrictions (over six years) on how much interest they could offer on deposits.

 

This kicked off a period where banks competed aggressively to increase customer deposits by paying interest on checking accounts. The overall result was disastrous for banking's bottom line. Net interest margins (NET) are a major indicator of a bank's profitability and growth. NET is the amount of money that a bank is earning in interest loans, compared to the amount it is paying in interest on deposits. That margin shrank year after year, but banks continued to offer high-interest checking accounts to attract new customers.

 

The Financial Crisis of 2009 put an end to most interest-bearing checking in the U.S. In an atmosphere of the "too big to fail" banking bailouts, paying interest on checking accounts seemed almost irresponsible. In addition, to support the economy, the Federal Reserve Bank pushed interest rates to historic lows where they remained for years.

 

It wasn't until the pandemic that the financial landscape began to change. Inflation, higher interest rates, and ultimately the Silicon Valley Bank (SVB) blowup, have conspired to refocus people’s attitudes toward money.

 

Why, therefore, haven't savers at least kept their cash in interest-bearing savings accounts? Theoretically, in a digital world, it is not difficult to move funds back and forth between savings and checking when needed. The simple answer is that up until a year ago interest rates were still too low to make much of a difference. In addition, few of us have been willing to take the time and effort to continually transfer funds, even if we are computer savvy. The banking sector has been counting on that.

 

The news that depositors of SVB were able to move funds electronically with a press of a button has encouraged commercial enterprises and institutions to do the same. In an economy where interest rates are climbing higher, moving cash deposits is now a priority among many corporate financial departments. As they do that, the retail public may start to realize that banks should be paying them interest on their money as well. It has already touched off a larger movement of deposits within the banking system than we have not seen in years.

 

Given the drain on deposits from less capitalized banks to larger banks, especially money center banks, the battle for retail customers has once again come to the forefront. You may have noticed a proliferation of checking account ads in the media lately. Banks are competing to pay you more for your deposits, but buyers should be aware of bait-and-switch tactics.

 

For decades, banks have used eye-popping interest rate offers to suck in new customers.  Shoppers should be attentive to just how long these great rates are in effect. Six months from now, you don't want to be told those deals no longer apply. Remember too that most banks try and avoid paying these same higher rates to existing customers.

 

In many cases, deals on interest rates by banks are marketed in areas where they have few customers but are not available to those in areas where they have a loyal customer base. What to do? A call to your bank might convince them to give you the advertised higher rate but don't count on it. Bottom line: to earn more on your money, you may need to open a new account and transfer money into it. That takes time and effort, but when interest rates are between 4-5 percent, it may be worth it.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.