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[NEW YORK] Once the Federal Reserve starts lifting interest rates off the floor, banks will get a nice boost to their profits, but depositors will not get much benefit.
The Fed, which has long telegraphed its intention to end its seven-year experiment with zero rates, may start raising rates as soon as Thursday. Whenever it does, banks can begin charging more for many loans, while they will not be in a rush to pay much more for deposits.
With the Fed having slashed interest rates and injected trillions of dollars into the economy since the financial crisis, banks have far more deposits than they consider necessary and are fine if some disappointed savers take their money elsewhere. Lenders are usually slow to lift the deposit rates, but because they are awash in money from depositors, they can take it particularly slow this time around.
Charging more on loans without paying much more for deposits will help the bottom line at most banks. Analysts at Morgan Stanley said 37 of 44 US banks they cover expect to earn more if interest rates go up. For example, Bank of America Corp estimated that a 1 percentage point rise in short-term interest rates would bring it an extra US$2.4 billion in pre-tax profits in the following year. Citigroup Inc put the annual windfall at US$1.9 billion.
The boon for banks at the expense of depositors underscores how the Fed's recent policies have created winners and losers. Record-low lending rates and some US$3.6 trillion in cash injections from the Fed have helped a wave of corporate mergers and leveraged buyouts, stemmed the mortgage crisis and boosted stock markets. But the loose monetary policy also squeezed savers, particularly pensioners who rely on bonds and bank accounts for their income.
"It has effectively been a massive wealth transfer from retirees and others savers into the pockets of indebted Americans," said Greg McBride, a financial analyst at bankrate.com.
Banks have profited from being the middlemen in that transfer and now it may still be quite a stretch before savers can feel any relief.
"Savers have been short-changed by low rates," said banking analyst David Hendler of Viola Risk Advisors.
Bank executives say depositors tend to think about switching to other banks or alternative low-risk investments once they see someone offering one extra percentage point in interest income. That time could be more than a year off, given that the Fed has not even taken its first step and many traders expect it to hold off until next month or December.
The good news is that when that time comes, competition for depositors could heat up quickly because of new capital rules adopted since the financial crisis, which force banks to rely more than before on funding from deposits by individuals.
Technological changes since the last 2004-2006 tightening cycle, including the rise of mobile banking apps, also make it easier for savers to compare rates and move money faster from one account to another.
In that last cycle, banks raised deposit rates by 0.46 percent of the 4.25 percentage points that the Fed lifted its rate. This time they could pass on closer to 0.49 percent of the Fed's eventual increase, according to an estimate by Novantas, which advises banks on deposits.
Bank executives say it is difficult to work out when savers might start thinking about taking their money elsewhere, but believe time, for now, is on their side.
Low inflation, falling global commodity prices and moderate economic growth suggest that any Fed tightening cycle is likely to be very measured and slow. Most investors expect at most one or two quarter-point rate hikes between now and July 2016, according to the CME Group's FedWatch tracking rate expectations in the futures market.
With the Fed having kept rates near zero since late 2008, rates on many short-term investments, such as money market funds have been close to nothing, and banks have also been flooded with cash that had nowhere else to go. Today deposits exceed loans outstanding by 40 per cent compared with about 9 per cent at the start of the last tightening cycle in 2004, a cushion approaching US$75 billion that banks might whittle down before starting to worry how to fund loans on their books.
For consumers, rates on deposits remain pitifully low. On average, banks have offered less than 0.25 per cent of annual interest on six-month certificates of deposits since August 2011, according to data compiled by BankRate.com. The rate was down to 0.17 per cent earlier this month, compared with 3.63 per cent in April 2007 when the Federal Reserve's benchmark rate was at its last peak of 5.25 per cent.
The last time the Federal Reserve began raising rates, in June 2004, it was 90 days before banks paid consumers higher rates for their basic savings accounts, said Dan Geller, who tracks the outlook for deposits at Analyticom.
It took 10 months for banks to pay even 0.2 percentage points more on so-called money market deposit accounts and by then the Fed's rate was up 1.75 percentage points.
"It will probably be much longer" this time before banks pay more Mr Geller said, given how high deposit levels are.