Raising Bank Rates May Depend on a Pick-Up in Lending Activity

As the economic recovery gets haltingly underway, one of the things depositors should keep an eager eye on is lending volume. It’s not that those depositors are necessarily looking to borrow money themselves, but a pick-up in the lending business may be a key in pushing bank rates higher.

You name it — CD rates, savings account interest rates, and money market rates have all been unusually low this year. There are many factors contributing to low bank rates, but one of them has to do with a dilemma banks have faced in the wake of the financial crisis.

In an effort to stabilize their businesses, bankers have sought to lower their loan-to-deposit ratios. Basically, loans represent a source of risk to banks, and deposits represent the liquidity that helps mitigate that risk. The problem is, as banks take on deposits while writing fewer loans, it becomes more difficult for banks to turn a profit on those deposits.

When the loan business is profitable, it means banks are earning more by lending out the capital they receive in the form of deposits. This makes those deposits more valuable to the banks — which means banks are willing and able to pay more in the form of interests on those deposits.

When the lending business stagnates, bank rates suffer because deposits can’t be put to profitable use. Bank rates would get a boost if lending business picks up, assuming that lending business is healthy (i.e., if default rates are low). So, depositors need to root for a pick-up in the loan business — even if they have no need of a loan themselves.