Is it possible that we are witnessing a paradigm shift in the way consumers view deposits?
Are consumers starting to view FDIC and NCUSIF-insured deposits from a pure insurance perspective as opposed to seeking interest income?
And if so, will consumers be willing to pay a premium for insured deposits as compared to earning interest on their deposits?
These are some of the questions stemming from the new economic reality that we may be facing in the not-so-distant future.
Understandably, you may be asking yourself: how is it possible that consumers will actually pay for their deposits to be held by the bank rather than gain interest income on those deposits?
The answer may surprise you: it's not just possible, but there is historical precedent. But first, let's look at some of the trends in deposits that may be leading the industry in that direction.
Deposit rates have been on the decline since late 2006, when the national average annual percentage yield (APY) peaked at 4.37%.
Today, the national average APY for deposits stands at 0.85%, which represents a decrease of 352 basis points (BPs) in 48 months, or an average decline of 7 BPs per month, which is a trend that continues as we speak.
Average APY Heading For Zero
Since most economists do not project any major improvement in the economy over the next 12 months-in terms of employment, housing and gross domestic product-is it possible that the national average APY for deposit will reach zero by this time next year. We are already seeing some of the signs that may lead in that direction.
Consider the case of Riksbank, Sweden's central bank, which in mid 2009 lowered its fund rate to -0.25% (yes, minus). This means that banks can fund their liquidity at no cost, or better yet, make a profit on their liabilities.
The unprecedented move by the Riksbank was designed to stimulate lending by making liquidity "free" to banks. In a case such as this, why would any bank opt to raise money in the retail market and pay for it? Hence, deposit rates will decline.
Watching The 'Swedish Experiment'
Other central banks, such as the Bank of England and the Federal Reserve, are closely watching the "Swedish experiment" because they both have a similar problem-"clogged arteries," which means that money remains in the banking system and does not flow out to the economy in the form of loans and lines of credit. Typically, this "negative fund rate" is the last resort after Quantitative Easing is not successful in stimulating the economy.
Back to the scenario of consumers paying for deposits as a form of insurance. With mortgage rates reaching record lows of 4% (30-year fixed), and the pressure on keeping the Net Interest Margin (NIM) at about 3%, how long would it be before mortgage rates reach 2.75% if demand for mortgages remains low? We might be seeing 2.75% mortgage rates by this time next year, which means that the APY on deposits will have to be -0.25% in order to maintain a minimal NIM of 3%.
Would consumers be willing to pay 25 BPs to insure their deposits? For example, would they pay an insurance premium of $250 a year (25 BPs on a 12-month CD) to ensure their $10,000 is safe and that if the bank or credit union defaults, they will get their money back? Normally no, but again, these are not normal times.
Considering the financial anxiety level of people, the uncertainty about the prospects for economic recovery and the trend in loan and deposits rates, I would not rule it out completely.
After all, who could have envisioned a zero Fed fund rate a couple of years ago? Yet, here it is.
Dr. Dan Geller is the executive vice president of San Anselmo, Calif.-based Market Rates Insight, where he oversees the research and analytics services of the company. He can be reached at email@example.com.