Are you ready for negative money market rates?
August 12, 2011
Just when you thought money market rates couldn't go any lower, now BNY Mellon is charging customers for certain deposits, rather than paying interest on them. In effect, this is a negative interest rate.
So far, the BNY Mellon policy applies only to deposits of $50 million or more, so it is still a long way from becoming the standard at your neighborhood branch. Still, it is an ominous development, and one you should understand in case it reaches mainstream consumer money market accounts.
The rationale behind negative interest rates
To think about the issue from a bank's point of view, the following are reasons behind the idea of charging for deposits:
- Banks have a right to pass along their costs. It costs money to take in deposits--from bank staff and security to the assessments banks pay to support FDIC insurance. If customers benefit from having a safe place to put their money, why shouldn't they pay some of the costs associated with providing that safety?
- Deposit accounts are in demand despite low interest rates. The 2007-2008 financial crisis and recent market turmoil have proven that people will flock to safe harbors even if interest rates are very low. This suggests that people might even go so far as to pay a premium for safety.
- Banks have reasons for not wanting to attract deposits. With the lending market weak and money-making investment opportunities scarce, banks are limited in how they can make a profit on deposits. In that situation, taking on additional deposits merely dilutes the bank's return on capital.
4 reasons negative money market rates are unacceptable
While banks may have a rationale for charging money on deposits, here are four reasons customers shouldn't accept the idea:
- Customers are already losing ground to inflation. From a purchasing power standpoint, interest rates are already negative; that is, they trail the rate of inflation. How much more can people be expected to pay for saving money?
- Customers have other choices. The banking market is highly fragmented, with thousands of FDIC-insured institutions available. Plus, customers have other alternatives, such as Treasury bills, for keeping their principal safe. So if a bank starts charging for deposits, customers will have plenty of alternatives to consider.
- How good are bank guarantees? FDIC insurance is the crucial safety net under customer deposits, but as for the banks themselves, after the financial crisis it is hard to imagine customers would find the industry so confidence-inspiring that they would pay a premium for a bank's assurance of safety.
- A surcharge on deposits is short-sighted for banks. Paying a bank to hold deposits doesn't make sense for customers, but nor is it smart for any bank with a long-term business plan. From credit cards to investment services, banks have other ways of making money from customer relationships. Also, there will be times in the future when there are attractive business and investment opportunities, and banks which have turned their backs on attracting capital will live to regret it.
The bottom line is, if your bank ever wants to charge for money market accounts, start looking around for alternatives. Chances are there will still be banks willing to pay you for the use of your money, and for the opportunity to do additional business with you.