Lending money at a 0% interest rate to anyone is a horrible financial decision in normal times, but these aren’t normal times. Americans have been hunkering down for most of 2020 due to the covid-19 pandemic.
They forgo vacations, getaway trips, fancy dinners, and other costly leisures. As a result, banks’ depository liabilities have been growing tremendously. According to the Wall Street Journal, U.S. commercial banks have $15.9 trillion in deposits.
Financial institutions started dropping their annual percentage yield (APY), interest paid on deposits since the pandemic to turn depositors away. However, lucky American workers who could do their work remotely without taking a pay-cut have more disposable income, which they are not ready to spend.
They continue to deposit their surplus funds at big banks. Lending money at a 0% interest rate to big banks does seem to bother this group.
Annual Percentage Yield
Annual Percentage Yield (APY) is the real rate of return earned on a savings deposit or investment, taking into account the effect of compounding interest.
For example, the Capital One Bank 360 Money Market’s APY dropped by 120 basis points (bps) since the pandemic. Depositors who choose to save with Capital One Bank gets about 0.30%
With an initial deposit of $10,000, which is often the required amount to open a money market account, the ending balance will be $10,030. The bank will pay the depositor $30 worth of interest income after 12 months.
Depositors with regular savings and checking accounts get between 1 or 2 dollars in interest income each year with a 10k deposit since those accounts’ APY hovering around 1 or 2 bps.
According to Bankrate, American Express Bank has the highest APY, which 60bps or 0.60%.
Big Bank Challenges
Banking, at its essence, is quite simple. Banks take deposits and pay depositors an APY, lend the deposits to entrepreneurs to build businesses, or potential homebuyers to fund their dream home or to consumers to renovate their house or go on vacation. Covid-19 added a significant level of uncertainty into that banking model.
To reduce their risk, banks are hoarding deposits. They don’t want to lend to that entrepreneur because covid-19 might have shifted her financial forecast or the consumer because her job is no longer stable. The bank’s risk aversion affects depositors’ APY.
What Can Depositors Do?
Depositors can funnel their funds to different asset classes, including bonds, stock, and others. However, depositors who might need their money in the next couple of years might not have any choice but to stay with their banks and earn that anemic APY.
The silver lining is banks still have great products such as online money transfer, bank ACH, Direct Debit Electronic Payment, and others that can compensate depositors for the extremely low APY.
