Savings Account Interest Rates Could Be Affected by Banking Proposals

Congress has returned to Washington, with the fervor to reform the financial industry still at a high pitch. Naturally, the banking industry is one of its targets. How might changing regulations affect your savings interest rates?

We've already seen one example of how regulatory action can impact savings accounts. As the FDIC has been forced to raise premiums for deposit insurance, the profit margin on these accounts has narrowed for banks. This is passed on indirectly to the consumer in the form of lower savings account interest rates.

With examples like that, it's understandable why people tend to associate regulation with higher cost. However, in the case of FDIC insurance, you could argue that it's not the regulation that is causing higher premiums and lower savings account rates--the root cause is the necessity of cleaning up some of the excesses that regulatory oversight failed to address previously.

Bank regulations, then, can result in benefits to savings account depositors and other bank customers. A current debate over raising capital limits on banks might be an example.

Proposed Reform of Capital Limits

The regulatory proposal in question would raise the level of capital banks have to set aside to cover investment banking activities such as securities trading. These more exotic activities had been the reason for the swift downfall of some large banks. The problem is that when a bank combines risky activities with more conventional business lines such as savings accounts, an investment setback at the bank can poison the entire well, putting those savings accounts at risk.

The idea behind a higher capital requirement is to take some of the leverage out of those risk-taking activities. Banks argue that this requirement would hurt their profitability, but that is the double-edged sword of leverage: it makes an institution more profitable when things go well, but it deepens and hastens the damage when markets go bad.

Possible Impact on Savings Account Rates and Security

This may seem like an esoteric banking-industry discussion, but real impacts could trickle down to conventional savings accounts. Would higher capital requirements make savings account interest rates higher or lower? What about the security of those accounts?

First, let's address savings account interest rates. Higher capital requirements should make savings account deposits more attractive to banks, because this steady, albeit unspectacular, source of profitability would help them meet their capital requirements for more ambitious business activities. In theory, this would give banks more incentive to attract deposits, thus push savings account rates upward.

As for security, some bank executives argue that the higher capital requirements would force them to abandon investment banking activities altogether. That's not necessarily good news if you are a shareholder in a bank, since it limits the bank's profit growth potential. However, if you are a savings account depositor, an abandonment of those activities might be good news. Customers who don't profit from a bank's riskier lines of business don't want their deposits jeopardized by those activities. Of course, FDIC insurance coverage limits--especially as they have been boosted through 2013--will protect depositors whether or not this regulation moves forward, but savers with deposits over the covered limits or who want to avoid the potential hassle of switching banks may take note.

This underscores how complex the regulatory discussion can be. Higher capital requirements could hurt some banks and some investors but at the same time might benefit savings account depositors.

Source:

Steven Sloan • Capital Plan May Force Hard Choice at Big Banks • Sep 09, 2009 • American Banker: http://www.americanbanker.com/issues/174_173/capital_plan_force_hard_choice_at_big_banks-1001798-1.html?ET=americanbanker:e538:2242572a:&st=email