With the Fed Funds Rate at the highest level since 2001, interest rates are the topic of many conversations between business leaders. Loan rates often take center stage in these discussions, but deposit yields are also an important consideration.
The interest earned on business cash reserves can help reduce the impact of inflation and even add to profitability. For these reasons, companies should do everything they can to maximize yield without sacrificing safety. This begins with understanding how deposit rates are set.
Which factors impact deposit rates?
Banks generally have autonomy in setting the rates they charge for loans and pay for deposits. They also have the freedom to change these rates to suit their needs – such as growing their loan portfolios or attracting new depositors.
While banks tend to set their interest rates to maximize profitability, there are several other factors that can influence their decisions. These include the Fed Funds Rate, geographic location, individual bank needs, and account type.
The Fed Funds Rate
The Fed Funds Rate influences the availability of credit and, indirectly, the economy. While this rate does not directly impact deposit yields, it contributes to them.
One way that The Fed Funds Rate contributes to deposit rates is by acting as a sort of baseline for loan rates. The Fed Funds Rate is the rate banks pay to borrow from each other, so banks tend to set their loan rates above the Fed funds rate to make a profit.
When the Fed Funds Rate rises – and banks earn more from loans – they can afford to pay higher deposit rates. However, just because banks can afford to pay higher yields doesn’t mean that they will. It also takes increased competition to convince banks to raise their deposit rates.
Competition for deposits increases when similar investments offer higher yields. One of these investments is short-term bonds. Since the Fed Funds Rate has an almost immediate impact on short-term bond yields, some depositors leave banks to invest in bonds when bond yields rise. For this reason, banks often raise deposit rates along with bond yields to remain competitive.
Geography and Bank Needs
In addition to competing with short-term bonds, banks also compete with each other for deposits. In areas with many financial institutions competing for the same customers, banks often pay higher-than-average rates to keep and attract depositors.
In addition to geography, bank needs factor into the yield they pay. These needs can vary widely and often result in higher yields at banks that need to attract new deposits.
Different types of accounts can offer different yields, even at the same bank. This is largely due to differences in liquidity.
In general, accounts with higher liquidity offer lower rates of return. For example, a checking account typically has a lower yield than a money market account because there are fewer limitations on withdrawals. In turn, a money market account tends to have a lower yield than a Certificate of Deposit [CD] because they offer easier access to funds. This is one reason why a company’s cash management plan needs to account for liquidity.
Differences in geography, bank needs, and account type can cause deposit rates to vary widely between banks and investments. These factors make it possible for businesses to achieve above-average returns for their cash reserves.
How To Find Above-Average Yields
Since deposit rates vary from bank to bank, a business could manually compare yields from hundreds of financial institutions across the country to find the highest rate. This process can be extraordinarily time consuming, especially since yields change often.
Modern financial technology – also known as fintech – offers a simple solution to locating above-average yields. With fintech powered deposit management, companies can achieve nationally competitive returns without the hassle of monitoring rates from many different banks.
Nationally Competitive Yields with Marketplace Banking™ By ADM
Our company, the American Deposit Management Co. [ADM] uses proprietary fintech to help companies achieve nationally competitive yields for cash reserves. We call this concept Marketplace Banking™ and it works through our nationwide network of banks and credit unions that compete for deposits.
Along with competitive yields, Marketplace Banking™ allows our customers to access extended FDIC / NCUA insurance so that every penny of their cash can be protected by government insurance. With our deposit management solutions, companies can achieve the safety, liquidity, and returns they need.
To learn more and get started, contact us.