Fed Funds Rate affect on Bank Savings Accounts

Jonathan from MyMoneyBlog has touched the topic that has always interested me personally: how Fed Funds Rate affects all these savings accounts.

Banks make money by borrowing and reinvesting funds and I would assume Feds Fund Rate is the benchmark they don’t want to go over when borrowing since this is the rate at which they can borrow from the government or from each other. On the other hand if they attempt to borrow at low rate (offer low interest rates on savings) they will have trouble attracting deposits from people.

To see the relation on a live example, Jonathan has collected historical data for savings rate at two popular online banks: ING Direct and Immigrant Direct. The result of his work is this chart:

Fed Rate and Savings

You can definitely see some correlation, but it’s not perfect. It looks like ING was more aggressive in 2002-2004, and then gradually become satisfied with fatter margins. Emigrant seems to be following the curve closely, which would indicate an interest rate drop soon.

The bottom line is that while there certainly is a correlation, each bank sets its marketing strategy differently and can offer savings rate higher or lower than Fed Funds Rate depending on how aggressively they need to attract deposits. Higher rate means more money coming in to the bank but less profits to make. Lower rate means less people opening deposit accounts but also means fatter margins for the bank. For more ideas on the subject read Jonathan’s blog post.

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