Why do high yield cash deposit accounts vary so much?

Exploring why is there such a large discrepancy between FinTech and incumbent interest rates

FinTechs have been entering the financial market for years, taking traditional banks products and services and enhancing them; savings accounts and cash deposit accounts are no exception. Traditionally, banks were the only providers of such accounts. Que the financial crisis and the rise of online banks who migrated towards offering high yield savings accounts when banks were beginning to move away. Over the last year or so, newer entrants such as Ally Financial, Wealthfront, Betterment and Robinhood have been competing with traditional players by offering relatively high yield savings accounts. ­­ Such FinTechs compete by offering above market average interest, lower required minimum deposit and no monthly maintenance fees.

Ally Financial offers its customers a high-yield cash deposit account with 2% annual percentage yield (APY). For instance, if a customer deposits $2.5K into the account and lets it mature for 12 months, the estimated interest they will make is $50. This is only an estimate as interest rates can – and do – fluctuate. Ally’s cash deposit account has no monthly fee and has no minimum deposit requirement, but there are penalties for early withdrawal before maturity. These tend to be a portion of the interest.  Wealthfront offers a 1.82% APY, with a $1 minimum required deposit to open the account and no additional or maintenance fees.

At the other end of the extreme sits some of the traditional banks such as Wells Fargo who offer ‘Wells Fargo CDs’. One of these cash deposits requires a $2.5K minimum opening deposit and has an APY of only 0.15% with an estimated return of $3.75 after 12 months maturity.

Though these examples are taken from more extreme ends, and are U.S.-specific, it demonstrates the vast difference in APYs offered.  This could be down to factors such as market risk, finances and wider market trends.

Traditional banks have a legacy, are larger scaled and have various brick-and-mortar branches. Specifically, they have a lot of overheads, the cost of which are passed on to consumers via a lower interest rate. FinTechs, however, are smaller, don’t have physical bank branches and employ fewer staff. Branch location also factors into offered interest rates with many state banks offering rates vastly below the market average.  For example, Wells Fargo advertises in the small print that the interest offered is the one for a given state and so may fluctuate based on a consumer location.

Market risk defines another factor which must be considered when assigning APYs.  Traditional banks may typically offer a lower interest rate to compensate for the cost incurred via unpaid or late loan repayments.  For some Fintechs, such as Wealthfront, the money in each account is not reinvested, meaning such companies don’t have as much risk to prepare for.

When the Federal Reserve lowers rates, banks and Fintechs will lower their rates in accordance.  Although this is good news for consumers with products such as loans and credit cards, it has the opposite effect on savers.  As early as June 2019, Ally’s APY for online savings accounts was 2.2% but when the central bank dropped the rates, Ally’s rates dropped by 30 basis points. Since June 2019, Ally has dropped its interest rate 3 times to 1.7%, though it is now advertised again at 2%. This was down to the Federal Reserve cutting its benchmarking rates to between 1.5% and 1.75%.

Some traditional banks, however, appear to use their experience and knowledge in this area to their advantage. Banks such as Barclays and Goldman Sachs’s ‘Marcus’ predicted these cuts and were able to inoculate the impact by gradually lowering their rates beforehand, softening the blow.

Reports on Wall Street claim the Federal Reserve will cut rates again, this prediction has been refuted by the Federal Reserve. Although lowering interest rates further would encourage spend, it would also cause inflation to rise faster, arguably having a worse effect on the economy. Furthermore, there were reports of the US President demanding rates to be lowered, even to negatives.  This was also the case for the European Central Bank who had cut rates into the negatives (-0.5%) to encourage an influx into the economy. For a while this was sustainable, and consumers were not being passed the burden. However, in Germany, banks have begun to pass on the negative interest as a cost to its customers. Many of Germany’s larger banks absorbed the cost or claimed to pass it on only to corporations and those individuals with high deposits.  However, The Raiffeisen Cooperative Bank is passing on the -0.5% rate to regular savers reportedly from their very first euro deposit.

The appetite for high yield savings accounts in Europe is not yet known, but we could see a trend of FinTechs, like Wealthfront, travelling across the pond in order to compete, or new homegrown start-ups. Alternatively, the lowered interest rates, though not negative in the U.S., could be passed to the consumers by traditional banks through even lower interest rates being offered. It will be interesting to see new trends emerging and what impact this will have on the future of high yield savings accounts.

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