Why Are Interest Rates So Low on Savings Accounts?

Inflation is at a 40-year high and mortgage rates have skyrocketed, climbing nearly 2 percentage points since the start of the year. The 30-year fixed mortgage rate now averages 5.30%, the highest since June 2009. With the Fed's recent announcement of rate hikes, several credit cards responded with half-point increases of their own. The average credit card interest rate is now 16.54%, coming close to 17% for the first time since early 2020.

While it seems as though interest rates across the board are increasing, unfortunately, the average savings rate in the country has barely moved, averaging just 0.7%. While credit card companies have increased their rates by 0.5% in the past month, rates for saving accounts have only inched up 0.01% from the previous month. Why are interest rates so low on savings accounts while other accounts continue to go up? Savings rates are determined by a variety of factors. Here are the factors impacting savings rates and how you can find the best savings account for you.

The interest rate on certificate of deposits (CDs), typically one of the highest-yield savings vehicles, aren't much higher. CDs currently average just 0.21%. Putting $1,000 in a CD will gain $2.10 in interest.

As of May 16, 2022, here are the national rates, which are the average of rates paid by all insured depository institutions and credit unions for which data is available, for the most common banking products.

Out of the 94 different industries in the U.S., the banking industry is the most profitable, with a gross margin of nearly 100%. The average among the other industries is about 35%. One of the primary ways banks make money is by borrowing money from depositors at a certain interest rate and then lending that money out to borrowers at a higher interest rate. The bank makes a profit from the difference between the two interest rates.

For example, banks borrow from people who put money in a savings account at 0.07% and then lend out that money as a 30-year mortgage at 5.3%. This bank gets to keep the difference of 5.23%. This difference can be much higher for personal loans and credit cards.

The banks will adjust the savings rate based on the supply and demand as well as the policies of the Fed. If there is plenty of supply and people are saving a lot, then the banks will not need to pay out as much interest. If people are not saving as much and the banks need more money to lend out, then they will raise savings rates to attract more depositors.

Currently, banks don't have to worry about competing for your money. Since COVID-19 began, the personal savings rate hit an all time high of 33.8% in April of 2020. This was the highest rate in the 62-year history of the measure. From the end of the Great Recession in June 2009 to February 2020, the personal savings rate averaged 7.25%. Since the start of the pandemic, however, it has averaged 17.9%.

According to the Federal Reserve, there are several reasons for this increased average saving rate:

• Households practicing precautionary saving during an economic downturn
• An inability to spend money due to business closures and social distancing guidelines
• Stimulus checks (or relief payments) distributed to a large majority of U.S. households

With Americans throwing money into savings, banks have little incentive to raise the savings rate. Prior to the pandemic, cash assets at commercial banks totaled $1.8 trillion. Cash assets increased to over $4.1 trillion in December of 2021, more than double the total in February 2020. Cash assets have slipped down slightly to about $3.4 trillion since the height of the pandemic, but are still near all-time highs.

While banks are sitting on tons of cash due to the pandemic, there has been a big slowdown in lending. The loan-to-deposit ratio at U.S. banks fell drastically since the start of the pandemic and reached 58% in Q2 of 2021, the lowest level according to S&P Global Market Intelligence's database, which goes back to 2003. This means banks are sitting on more deposits than they ever have.

On top of the high amount of deposits and fewer opportunities to loan out money, the Fed pushed the reserve requirement ratio (RRR) to 0% in March 2020. The RRR is the amount that banks must keep based on the deposits they have. If the RRR is 10%, then to lend out $10,000, banks must keep at least $1,000. But with the RRR dropping to 0%, banks could lend out more money with the same amount of deposited money.

In addition, to help the economy during COVID-19, the Fed increased the money supply through its quantitative easing policy in March 2020. By purchasing massive amounts of debt securities, it flooded the economy by $120 billion per month until November 2021. The Fed's monetary policy combined with the government stimulus programs have also impacted the savings rate.

When banks need your money, they will raise the savings rate to attract customers. Banks lose money when they pay out higher rates, so they keep them low in order to maximize their profits. Despite the largest increase in the Federal funds rate in 20 years, banks have more money than they need, so they have continued to keep savings rates low.

Typically, high inflation leads to higher interest rates, which translate to higher savings rates as banks compete for more deposits. That hasn't been the case during 2022. If banks want to decrease deposits, then they will lower interest rates. Until demand for loans picks up and banks see a need for more deposits, interest rates will continue to stay low.

Even though interest rates on savings accounts are low, it is important to shop around to find the best rates. Online-only banks tend to have better rates since they do not have to pay the same overhead costs as brick-and-mortar banks.

An online high-yield savings account may offer higher rates, and credit unions may as well. CD and money market accounts typically offer higher rates than savings accounts. These could also be alternatives to try for a better rate.