Perfect Storm for Rising Deposit Rates
The second quarter of 2013 (ending in June) marked the second consecutive quarter over a six-year period that deposit balances in FDIC-insured institutions declined in response to lower interest rates. In that quarter, total domestic deposit balances declined by $31 billion (0.3%) compared to the first quarter of this year. In the first quarter, the decline was $20 billion or 0.2%.
This overall decline in balances is an indication that interest rates on deposits are likely to start climbing in the remainder of this year and into next year due to the increased sensitivity of deposit balances to decreasing rates. Financial institutions will need to start raising interest rates on deposits in order to maintain current deposit levels and to increase liquidity ratios as mandated by the Basel III regulatory framework.
The recent decline in domestic deposit balances comes after six years of continued increase in balances despite a record fall in deposit interest rates. This decline in deposit rates began in July 2007, when the national average rate for deposits stood at 3.28%. Afterward, the national average rate for deposits fell continually and reached its lowest level of 0.28% in July of this year – a decline of 300 basis points or 91% in the yield value during the six-year period.
During that period, July 2007 to July 2013, total domestic deposit balances increased from $6.7 trillion to $9.4 trillion, a rise of $2.7 trillion or 40%. This robust increase in deposit balances came despite the 91% fall in interest rates, indicating that deposits were very inelastic – or not sensitive to rate changes – during those six years. However, we are now seeing that the elasticity curve is flattening, meaning that deposits are becoming more sensitive to changes in interest rates.
Both deposit categories, time deposits and liquid accounts, declined in the second quarter of this year. Time deposit balances declined by nearly $12 billion or 0.7% and total balances of liquid accounts dropped by about $19 billion or 0.2%. However, some types of deposits demonstrated less sensitivity to low interest rates. Balances for certificates of deposit (CDs) of three months or less rose by $26 billion or 5.5% and money market account balances increased by nearly $50 billion or 1.1%.
We believe that deposit rates are currently at their turning point and are very likely to start a gradual and moderate increase between now and mid-2014. Once the Federal Reserve increases the federal funds rate, which is projected to occur in the second half of 2014, deposit rates are likely to increase at a greater pace.
All in all, we are seeing a perfect storm in banking deposits. First, the yield elasticity curve for deposits is flattening; meaning that demand for deposits is becoming more sensitive to lower interest rates. Second, deposit rates have reached their turning point as the national average rate for deposits remained flat in July and August of this year after six years of continuous decline. And finally, higher demand for lending and greater liquidity requirements will push interest rates for deposits higher.
Mr. Geller is the executive vice president of San Anselmo, Calif.-based Market Rates Insight, which provides competitive research and analytics to financial institutions. He can be reached at [email protected].