The unprecedented rate announcement from the Federal Reserve's Open Market Committee on Tuesday was bad news for savers -- two more years, at least, of short-term interest rates close to zero percent.
Short-term interest rates as set by the Fed directly influence all manner of consumer loan and deposit products, from car loans to CD rates.
Unfortunately, that's not the only bad news for savers and CD buyers. The increase in economic uncertainty that led to the FOMC's decision to keep rates extremely low also bodes ill.
Uncertainty makes people seek safety. With a sharp swelling of deposits at banks coupled with a decrease in interest income at financial institutions, interest rates on savings accounts and CDs may have nowhere to go but down.
As my colleague Claes Bell wrote last week, at least one institution is now charging large depositors to hold their money.
Bank of New York Mellon is so flooded with deposits it told large depositors this week it would soon start charging them for holding their cash.
Deposits are an expense for financial institutions; they must pay interest to the depositor and pay into the FDIC insurance to cover those funds. As a result, deposits of more than $50 million at Bank of New York Mellon will now be charged 13 basis points of interest.
An astonishing development, but it may not be isolated to big-money types. That trend could reach average banking customers in the form of increasingly low savings and CD rates -- as low as zero percent, according to Dan Geller, executive vice president of Market Rates Insight, a banking industry analysis and consultant.
"Although Bank of New York Mellon is a custodial bank for pension funds and mutual funds, we believe the same conditions that exist for them are there for retail banks and will trickle down to retail consumer banks," Geller says.
Here's why: Banks are earning less income from loans this year than they were last year. According to Geller, interest income as a percentage of assets stood at 4.20 percent in the first quarter of 2010. At the end of the first quarter this year, it was 3.88 percent.
The Fed's announcement of an extremely prolonged low rate environment may put more downward pressure on loan rates.
"If money is going to be cheaper for the banks they will pass it along to lenders and stimulate lending. To do that, banks will have to lower interest rates on loans even further. If that happens there is no room to pay interest on deposits, says Geller.
"Generally speaking a bank must maintain 3 percent net interest margin to stay healthy. Right now the interest income stood at 3.88 percent of assets. If this goes down to 3 percent then interest rates will have to go to zero," he says.
Decreased income from loans and increased expenses in the form of deposits means something has to give. At this point, lower CD rates are hypothetical but not far from the realm of possibility. Geller says he first floated the idea of negative yields last October and was met with disbelief.
"When we projected this last year it was ridiculed. But its simple math, you look at the math its unsustainable," he says.
Use Bankrate's rate tables to search for high-yield CDs around the country.
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