As banks prepare for a recession, they are cutting back on lending, which is bad news for savers. Banks have been waiting for loan demand to increase for the last two years, and banks are tightening their lending standards now that borrowers are knocking on their doors. They don’t need to attract funds, which is why deposit rates have barely budged.
A common complaint is that banks only extend credit to those who don’t need it. That was true for much of the pandemic. Due to easy fiscal and monetary policies, households and businesses found themselves flush with cash and little need to borrow. Despite banks sitting on record deposits, they could not lend, even though they had more than enough capacity to do so.
Fast forward to the present, when persistently high inflation has begun to weigh household and business cash reserves, causing them to borrow money. According to a recent Raymond James report, loan growth increased by 4.1% sequentially in the second quarter.
But banks have tightened lending standards, bracing themselves for a potential recession and seeking to meet the Fed’s capital requirements. According to the report, some banks also said that they worried about weakening demand in secondary markets for those loans, meaning they would have to hold them on their balance sheets.
Moreover, banks said they intend to continue tightening their standards for the second half of the year due to fears that borrowers will continue to be hampered by inflation and will face difficulty repaying their loans. The banks also worry that collateral values—which ran up during the pandemic—will deteriorate, giving them more reason to be cautious.
For bank investors, this isn’t great news. One can’t fault banks for being prudent but doing so also stifles growth. This caution comes amid a turbulent two years in which the sector initially plunged due to the pandemic-induced economic shutdown. Investors hoped that the Fed’s rate hike plans would result in continued gains for the industry as banks earned more on their loans. To benefit from higher rates, banks must be willing to lend.
Despite this, savers have more to be upset about than bank investors. For over a decade, savers have been earning little or nothing on their deposits due to low-interest rates. Increasing interest rates should have changed that. So far this year, the Fed has lifted rates by 225 basis points, or 2.25 percentage points. Borrowers’ financing costs have risen as a result, but savers have yet to reap the same benefits.
Most likely, deposit rates will take some time to rise significantly. With high deposits, legacy big banks don’t feel much pressure to raise depository rates.
Since lending is where banks make their money, there is usually a lag between when the interest rates stop rising and the bank’s depository rates rise. Although deposit balances are dwindling in the face of inflation, they remain elevated from pre-pandemic levels. As a result, banks see little incentive to raise deposit rates when they are not competing for business with other banks.
Isfar Munir, a Citigroup analyst, wrote in a recent note that banks should not compete for deposits in the near term, given that reserves remain broadly ample.
According to a recent Keefe, Bruyette & Woods report, the banking sector’s loan-to-deposit ratio was relatively low going into the Fed’s tightening cycle, standing at 75% in the first quarter of 2022. The loan-to-deposit ratio is 15 percentage points lower than at the start of the tightening process in 2016-2018.
All told, the rest of the year will be frustrating for bank investors but maddening for savers. However, there are a few ways for savers to get slightly higher yields on their idle cash.
One way to squeeze a little more money is to consider online banking. Currently, online-only banks have between 1.5% and 2%. As they have low overhead, they can offer higher yields in any interest rate environment, so they began raising from higher bases. Since online-only banks face more competition, their rates have risen more recently.
Among these banks are established names that operate under their federal banking charter, like Ally and Goldman Sachs’ Marcus, and “neobanks” like Chime, that operate under another company’s banner. Regardless, your money is insured by the Federal Deposit Insurance Corporation. Traditional online-only banks generally offer higher savings interest rates than neobanks, and it is common for neobanks to offer no-fee checking accounts that are popular with young people. Customer support at legacy online banks tends to be better than that at neobanks.
Certificates of deposit
If you don’t mind tying up your money, you can also score higher rates by opening a certificate of deposit. For emergency funds, liquidity is paramount, but CDs offer competitive rates these days for cash; you can lock up from a few months to five years or more. Again, you’ll be able to get better rates online than in-store. Marcus, for example, offers 2.30% APY for a one-year online CD and 3.20% for a five-year CD.
All told, the rest of the year will be frustrating for bank investors but maddening for savers.