Windypundit

While I’m between jobs, I’ve been tinkering with the family finances, and I’ve learned a thing or two about banking. It’s nothing personal finance experts haven’t known for years, but I find it fascinating, so I thought I’d share. And while it’s not quite financial advice, you might get something useful out of it. Be warned, however, that I’m going to talk a lot about interest rates.

If you’ve been paying attention to financial news, you might know that the Federal Reserve lowered interest rates a few weeks ago, and you probably also heard that President Trump wants rates lowered even further. In this case, the interest rate we’re talking about is the federal funds rate, which is the rate banks charge when loaning each other money.

After the latest change, the Federal Reserve will be targeting a rate between 2 and 2.25 percent, which is on the low side from a historical perspective. However, when the mortgage crisis hit the U.S. in 2007, the ensuing collapse dried up the supply of credit, and the Fed tried to get money flowing again by pushing the federal funds rate down below 0.25%. It actually got down as low as 0.04% a few times, which is almost free money.

Even if you weren’t paying attention to the Fed back then, you probably noticed the effect on your bank account: Interest rates plummeted to effectively zero. That’s because banks no longer needed your money to fund loans. They could borrow from other banks at rates often below 0.20% and sometimes as low as 0.05%. Furthermore, consumer savings accounts have a lot of overhead — maintaining branch offices, printing statements, operating ATM networks, hiring customer service personnel — all of which ate into the profits they could make by loaning out your money. Many banks dropped their rates to 0.01%, meaning a $10,000 savings balance would only earn a single dollar in an entire year.

The Great Recession is gone now, and the low rates went with it. The federal funds rate was 2.40% last month, meaning banks now have to pay about ten times as much to borrow money from each other as they did during the recession. So we might expect that banks would have to offer comparable rates on savings accounts to bring in the cash they need. Even with the additional overhead of retail banking, you’d expect savings accounts to be paying around 2.00%.

And yet they’re not.

For example, Citibank is offering a rate of only 0.04% across all its savings plans. Bank of America is offering 0.03%, and Chase and Wells Fargo are both still at 0.01%. (In all cases, I’m ignoring limited-duration promotional rates.) If you poke around on these banks’ websites, you’ll find they’ll go a little higher if you deposit more money. Bank of America goes to 0.06% if you deposit $100,000, but Wells Fargo will go to 0.15% for the same amount. Chase will go to 0.11% for $250,000, and Citibank will go to 0.15% only if you deposit $500,000 or more.

So how come these banks pay around 2% when borrowing from each other, but when they borrow money from you in the form of a savings account deposit, they pay no more than 1/13th of that rate, and in some cases as little as 1/200th of that rate? What’s going on?

To some extent, they’re just taking advantage of you. If you have a relatively small amount of money in the bank, the difference between earning 2.00% and earning 0.01% is only going to be a few bucks per month, which might not be worth worrying about. But for a bank with millions of accounts, that difference adds up to a nice profit.

Still, even with the relatively small amounts at stake for most people, you’d think the market would still grind away until banks were forced to compete on rates. The fact that they don’t makes me suspect that maybe retail savings banks simply can’t compete.

The banks I’ve mentioned — Chase, Bank of America, Citigroup, and Wells Fargo — are the four largest banks in the United States, operating a combined total of 22,000 bank branches and employing 900,000 people. That costs them a lot of money, maybe enough money that they can’t afford to offer better rates.

Compare those expenses to a bank like Capital One. You’ve probably seen their endless stream of credit card ads, but did you know they also have regular bank accounts? With fewer than 800 branches and 50,000 employees, they also have lower costs, so you might think they could offer a better savings rate, and you’d be right. As I write this, you can get a straight 1.00% on a savings account, more than six times the regular rate from the big four banks.

But what if banks cut operating costs even further? Ally Bank only has about 8,000 employees and they are purely an online bank that operates no branches. You bank with them using websites, phone apps, ATMs, phone support, and the occasional mailed document. They’re keeping their overhead low, which is probably why they’re able to offer 1.90% interest on a savings account.

We can do even better if we’re willing to give up a lot of banking conveniences. For example, it turns out Goldman Sachs isn’t just for the super-rich any more. Their Marcus product line includes a high-yield savings account paying 2.15%, and unlike those banks that make you deposit $100,000 for just 0.15%, there’s no minimum deposit. You could have a high-yield savings account at Goldman Sachs for a dollar.

The downside of using Marcus is that a savings account is the only banking product they offer. Even at a no-frills bank like Ally, you can get a checking account and you can move money between savings and checking instantly on their website. They also offer online bill payment, and you can withdraw cash through an associated ATM network. But if you open a Marcus savings account, you get none of that. The only way to move money in or out of the account is to do an electronic inter-bank ACH transfer to or from an account at another bank, which typically takes a few days.

If you can live with the inconvenience, there are several more of these high-yield savings accounts out there, if you take the time to find them. So far, the highest rate I’ve found is a Popular Direct account paying 2.55%. That account is no more convenient than the Marcus account, plus they want a minimum opening deposit of $5,000, and they’ll charge a fee if your balance drops below $500, so it’s definitely not for everyone.

My personal solution is to use a regular bank for checking services, bill payment, and ATM withdrawals, while keeping my savings in a high-yield account at another bank. Currently, my savings are in a Wealthfront cash account paying 2.32%. This is an ACH-only account like Marcus or Popular Direct, so I can’t get money in and out fast, but I can live with that because I’m only using this account for money I won’t need in a hurry, such as reserves for home repair or riding out unemployment. I feed the account with periodic ACH transfers, and I can transfer the money back to my checking account when I need it.

Wealthfront isn’t actually a bank. It’s a brokerage, and this account is basically their cash sweep account, which is where they park cash that’s not invested in the market (although I don’t have to have investments to have a cash account). Wealthfront doesn’t hold the cash themselves. Instead, they make deals with several banks to hold it for them in regular savings accounts in their customers’ names, thus ensuring the money is safely covered by FDIC insurance. In fact, if your savings balance exceeds the $250,000 FDIC limit, Wealthfront will spread your money across several banks, keeping each account below the limit, so you are completely protected for cash deposits up to $1 million. (Alas, not a service I need.)

This leads to a bit of a twist: My statement shows which bank Wealthfront has put my money in, and the answer is somewhat surprising…

Citibank.

That’s right, the same Citibank which pays its regular customers only 0.04% is paying me more than 50 times as much, which seems pretty crazy.

Part of the reason they pay me more is undoubtedly the increased bargaining power that comes from Wealthfront aggregating my money with that of thousands of other people. Wealthfront is offering to place millions of dollars, so they can make certain demands on banks.

Another reason Citibank is willing to pay a higher rate is the the low administrative cost of accepting deposits through Wealthfront. Citibank never has to process my application, cash my checks, or talk to me on the phone. Wealthfront creates and manages all the accounts over the internet and transfers the cash by wire.

Finally, I can’t prove it, but I’m pretty sure another reason Citibank pays me more than their regular customers is what economists call price discrimination. That’s something businesses try to do when different customers are willing to pay different prices for the same item.

For example, a grocery’s low-income customers might only be willing to pay $5 per pound for ground coffee, whereas high-income customers may be willing to go as high as $8 per pound for the exact same coffee because they are not concerned about a $3 difference. If the grocery sets the price at $8/pound, they will maximize their profit per pound, but they will lose all the sales to low-income customers who won’t pay more than $5/pound. However, if they set the price at $5/pound, they will lose the $3/pound profit from selling to high-income customers.

Ideally, the grocery would like to offer different prices to different customers based on their income, but they can’t just ask. And even if they could, how would they keep high-income customers from saying they have low incomes just to get the better price?

One solution is to find a way to make customers reveal their price preferences. The grocery could put a table full of 1-pound canisters of coffee at the front of the store, priced to sell at $8 each, and they could also stock a shelf full of 2-pound canisters for $10 each at the back of the store. Low-income customers will know they can get a good price by walking to the back, whereas high-income customers will just grab the $8 canisters because they don’t really pay attention to the price.

I think Citibank is doing the same thing. I shopped around for savings interest rates, and like the customers who walk to the back of the store, I found a good price. Other customers who don’t care about savings interest rates just opened a savings account at whichever bank was most convenient.

The bottom line is that it can pay to shop around for a savings account. Although it doesn’t pay as much as it used to. Back in the late 1970’s and early 1980’s, inflation drove federal funds rates much higher, often more than 10%.

This was a problem for the specialized system of “Savings and Loan” banks, which were chartered under special rules that prevented them from paying more than 5.25% interest. But the rules did not prevent them from offering customers “gifts” for opening an account, so Savings & Loan banks tried to entice customers by filling their front windows with piles of stuff — everything from toasters to televisions — to make up for the poor interest rate they were offering.

They don’t do that any more, but if you shop around for rates, you might find one high enough to buy yourself a nice toaster.