Deposit Pain Eases for Banks as Fed Rate Cut Nears
The financial landscape for banks is showing signs of easing as the pressure from higher interest rates on bank profits appears to be abating. The banking industry is preparing to reduce payouts to depositors in anticipation of a potential rate cut by the Federal Reserve.
Over the past two years, banks have vied for the cash of consumers and businesses, offering higher interest rates on deposits due to a stall in loan demand. This competition is now cooling, allowing banks to offer slightly lower rates on certificates of deposit and online-only savings accounts, despite the Federal Reserve not yet initiating a rate cut.
Analysts are forecasting the possibility of the Fed cutting rates as early as next month, a move that would relieve banks from the heavy competition and high interest payments to depositors that marked the recent period.
Eric Chan, an analyst at Morningstar DBRS, succinctly stated, “What goes up must come down.” He highlights how high deposit costs have negatively impacted banks’ net interest income, which is the revenue generated from the difference between the interest banks earn on assets and the interest paid to depositors.
Recent data indicate an inflection point for banks, with the median net interest income at midsize and regional banks showing a decrease of 1.2% from the previous year but a near 1.9% increase from the last quarter. This suggests a turning point where banks begin to recover from the strain of high deposit costs.
Early indications of this shift were observed when online-only banks like Ally Financial, Discover Financial Services, and Marcus by Goldman Sachs adjusted the rates of their high-yield savings accounts downwards, albeit slightly. This move signals banks’ strategies to reduce rates just enough to save money without alienating depositors.
Despite the reduction in interest rates for new CDs from 4.9% last year to 4.75%, banks have successfully retained a vast majority of their customers, with retention rates in some cases reported to be 95% and above. By offering shorter maturity CDs, banks aim to adjust more quickly to future rate decreases by the Fed, enabling them to move customers to lower-paying deposits.
Morgan Stanley analyst Manan Gosalia highlights this strategic positioning as an opportunity for investors to focus on midcap banks, anticipating improvements in banks’ interest income as the Fed commences rate cuts.
Although some banks may still need to offer competitive rates for deposits due to various growth strategies or liquidity requirements, overall, the steep increase in funding costs that pressured banks last year is showing signs of stabilization. This is evident in both the consumer deposit market and the brokered CD market, where banks acquire additional but typically more costly funds.
Furthermore, the shift of consumer deposits from non-interest-bearing accounts to interest-bearing ones is nearing a “floor,” suggesting that the trend may soon plateau. While challenges remain, including ongoing competition and uncertainty regarding future interest rates, the banking sector is cautiously optimistic that the worst of the high interest rate impact is behind them.
As the Fed’s next move remains highly anticipated, the banking industry stands at a pivotal point, preparing for a potential shift in monetary policy that could redefine the landscape of deposit rates and net interest margins.
