Banks, robo-advisors, and other fintechs are all going after savings and checking account dollars by offering impressive rates on deposits.
Since 2015, the Federal Reserve has been raising interest rates from near zero to today’s rate of 2.25% - 2.50%.
Rate hikes typically translate to better returns on savings accounts as banks can make more money on deposits in higher-interest climates. This has sparked something of an interest rate war — and savers are going to win. FDIC-insured online banks like CIT are currently topping Bankrate’s charts with a 2.45% APY (annual percentage yield), and others are not far behind — including some banks that offer a full suite of checking and savings services.
“For the first time in a decade, cash returns are above the rate of inflation – at least on a pre-tax basis,” says Greg McBride, Bankrate’s chief financial analyst.
With established players like CIT paying generously for deposits and offering easy online signups, the bar is high for other businesses who want your dollars. In 2017, a company called Beam began offering invitations to a savings platform that could pay between 2% and 4% APY, far above the average, which Bankrate still pegs at 0.10%, and even above most online savings accounts, which pay around 2.25%.
On Tuesday, a new online “banking service” called Varo Money — it uses a private-label bank called The Bancorp’s (TBBK, which is not to be confused with US Bancorp) FDIC membership and infrastructure — announced a 2.80% APY. There are small strings attached, like $1,000 direct deposit per month and using a debit card five times a month. (The rate is 2.12% otherwise.)
Rates like that are often both a form of marketing and the needed incentive to try something new and less-tested, says Morningstar analyst Michael Wong.
“If it’s an online offering from an online established institution from Charles Schwab, Wells Fargo, Goldman Sachs, you can be pretty darn sure the bank will be around,” he says. “When you start seeing extremely high rates from banks you never heard of, fintech players that have become more bank- and brokerage-like, I can understand why people would be a little more reluctant to part with their deposits. And that’s partially why they have to offer high rates.”
Varo did not answer questions about its business model and how it can afford to pay out rates that high profitably for the long haul, but said “we have no plans to change the rate — we want to send a real signal that banks should be on the side of savers.”
It’s entirely possible that the combination of online accounts’ low costs to operate and higher rates from the Fed could result in a wildly good deal for consumers like Varo’s, or better.
With higher federal fund rates, financial institutions can make a lot more off savings accounts. In the past three years banks’ net interest margin has risen around 10% on average, according to the St. Louis Fed.
“Net interest margin for a bank could be over 250 basis points (2.50%) , 300 bps (3.00%), so they can still make a spread off that,” Wong said. “It really depends on the business model.”
Brokers and robo-advisors are doing it too
On Monday, new investment platform M1 Finance, a free investing platform, announced it would be offering checking accounts to its users, complete with a debit card and 1.5% interest for $125 per year. (A balance of around $9,000 would make that fee back, depending on your tax bracket.)
M1 isn’t the only one. It follows Betterment, Robinhood, and other fintech companies that are getting into cash management, offering services to consumers that minimize the opportunity cost of holding cash in accounts that don’t make much money. The goal is the same: maximize return without losing liquidity of an emergency account or money that will be used soon.
Robinhood’s attempt at getting into the game ended in embarrassment as the hefty 3% interest-bearing checking account was, in the end, not “guaranteed” by the government. (Robinhood essentially tried to use a loophole to get deposits protected.)
Unlike Robinhood’s botched attempt, the M1 Finance “Spend” account offers 1.5% interest and will be FDIC-insured up to $250,000 using Iowa-based Lincoln Savings Bank’s membership.
Robo-advisor Betterment’s cash management product offers 2.09% APY, but makes up for the lower rate by automating the process to make sure your money is invested efficiently. Those funds, however, are not FDIC-insured. Instead, the risk is managed by investing 80% in U.S. Treasuries and 20% in high-quality corporate bonds.
Every investing platform is different, but one of the reasons for these “cash management solutions” beyond pure marketing and customer acquisition is that cash deposits are a great way to make money.
Like banks, which earn money from customer deposits by using the money to then make loans, investment platforms can enjoy a similar relationship. In the old days, Morningstar’s Wong said, money market accounts would have been the main cash option and would earn the bank a management fee.
But with today’s higher interest rates, net interest margin — the difference between what a bank pays out in deposit interest and what a bank collects from loan interest— is often more profitable than a management fee.
“Maybe you might earn 25 to 50 basis points (0.25 to 0.50%) in management fees for a money market [account],” says Wong. But if a bank can lend out money from customer deposits, it can earn 200 or 300 basis points or more, says Wong.
Even if this isn’t necessarily a path to another revenue stream for a financial services company, having cash management services or high yields for liquid savings or checking accounts is something that more customers want. Providing it could mean the differentiating factor between one option and another in the competitive environment.
In the end, it appears savers will win.