The first Fed meeting of 2018 has started today. The FOMC statement should be released on 2:00pm Wednesday. Even though no rate hike is expected to be announced at this meeting, 2018 should be another year of multiple Fed rate hikes. How will this affect deposit rates? To help answer that question, we did an analysis of our proprietary banking data with a focus on savings account rates.
After three Fed rate hikes in 2017 and after a total of five rate hikes since the Fed started normalizing rates in December 2015, most brick-and-mortar banks are still keeping their deposit rates at the same rock-bottom levels. However, online banks have been responding to the Fed rate hikes with higher deposit rates.
Rates Rising 3x Faster at Online Banks Than at Brick-and-Mortar Banks
Interest rate data collected from savings accounts from 6,548 banks and credit unions shows that savings account rates at online banks have risen 3x more than at brick-and-mortar banks and credit unions since the start of 2017. The average savings account rate at online banks has increased 43%. During that same time, the average savings account rate at brick-and-mortar banks has risen by only 13%.
Online banks have lower overhead, which gives them the ability to pass along their savings to consumers through higher deposit rates. In a previous study, the average savings account rate at online banks was shown to be about 4x the average from brick-and-mortar banks. This current study shows the difference in rates between the two types of banks not only at one point in time, but during a period of time that starts before the Fed began normalizing rates.
From 2015 to the start of 2017, the average savings account rate at online banks remained about 4x the average from brick-and-mortar banks. In 2017, this gap between the two averages widened as rates at online banks increased 3x faster than at brick-and-mortar banks. By the start of 2018, the average online savings account rate at online banks exceeded the average at brick-and-mortar banks by almost 6x.
The following chart details how interest rates have changed at online banks, brick-and-mortar banks and credit unions. The average interest rates at each of the three types of institutions are plotted starting in the second quarter of 2015 and ending in the first quarter of 2018.
In the second quarter of 2015, the average interest rate of savings accounts at online banks was 0.63%, which was 4.2x the average rate at brick-and-mortar banks (0.15%) and 3.7x the average at credit unions (0.17%).
The first two Fed rate hikes in December 2015 and December 2016 had essentially no effects on the savings account rates at brick-and-mortar banks and credit unions. By the first quarter of 2017, the average rates at brick-and-mortar banks was still 0.15% and the average rate at credit unions was still 0.17%. The average savings account rate at online banks increased slightly to 0.67%, a rise of 6%.
Interest rate increases at online banks accelerated in 2017 as the Fed raised the federal funds rate three more times. The average savings account rate at online banks increased from 0.67% at the first quarter of 2017 to 0.96% at the first quarter of 2018, a rise of 43%. During this same time, the average savings account rate at brick-and-mortar banks increased only 13%. At credit unions, the average increased only 6%.
Reasons Online Banks Are Responding Faster
Online banking customers tend to be more rate sensitive than customers at brick-and-mortar banks since that’s the primary reason for opening an account at an online bank. In addition, the electronic funds transfer systems at online banks that allow customers to link to brick-and-mortar bank accounts also make it easy for customers to move their money to other online banks that are offering higher rates. This results in a very competitive environment in which internet banks must increase their rates to maintain deposits.
Online banks also have another competitor. Money market funds at brokerages offer savers another conservative place to earn interest. These money market funds are not FDIC insured, but they are generally considered a safe alternative to savings accounts at banks or credit unions. During the years that the Fed held the federal funds rate near zero, most money market fund yields were 0.01% or 0%. As can be seen in the above chart, the average savings account rate was 0.63% in early 2015. This average was never much lower in previous years. Thus, savings accounts at online banks had a huge rate advantage over money market funds. Money market fund yields have risen with the Fed rate hikes, and now have yields comparable to online savings accounts.
More Reasons to Move Your Money to Online Banks
For higher rates now and for even higher rates as interest rates rise, this study shows the clear advantage online banks have over brick-and-mortar banks. To best take advantage of online banks, rates should be periodically reviewed since not all online banks remain competitive. At the start of 2018, the average savings account rate at online banks as shown in the above chart is 0.96%. Much higher rates are currently available at many online banks. Nine online banks now offer yields of 1.50% and above on no-minimum savings accounts.