05 Sep Why do banks offer better interest rates for new customers?

Q. When banks now advertise high interest rates, I don’t understand why they just don’t offer the best rates on all of their accounts. I wanted to get a rate I saw but the bank said it was only for new customers. Is that fair? I don’t think it is.
— Feeling snubbed

A. You’re right that banks often offer better rates to new customers.

You’re also right that it doesn’t seem fair, but it’s unlikely to change.

Banks are in the business of attracting deposits and using those monies to make loans or buy securities, said Tom Kolefas, a certified financial planner with Modera Wealth Management in Westwood.

“Their profit is the difference between what it costs them for those deposits and what they can earn on the loans and securities,” he said.

One of the major costs is the interest paid on the deposits but there’s also everything else – overhead such as developing mobile apps, providing conveniently located branches and ATMs, providing checkbooks, statements and fancier services such as cash management for businesses and more, he said.

What is the purpose of all these bells and whistles?

“They are designed to induce you to bring your deposits to them,” Kolefas said.

Once a bank has attracted your deposit — convinced you to open a checking or savings account or buy a Certificate of Deposit (CD) — they have a known all-in cost, which is the interest expense and overhead, and will try to pair that with a higher-yielding asset, such as a loan or security, that will give them the profit percentage or spread that they seek, he said.

“They are not going to want to pay more — give you the higher advertised rate — for `old’ money because that will only eat into their predetermined profit spread on your deposit,” he said. “They will only pay the higher rate for new money because they can turn around and lend that out at the new, higher, overall rates in the securities markets or loan market, thus maintaining their desired spread.”

Kolefas said that if banks paid the highest rates to all their accounts, they would merely be raising all their costs and cutting into their profitability.

A possible alternative is to pull your money from one bank and deposit it as new money at higher rates at another bank, he said.

He said there are frictional costs and inertia that keep many customers from doing that, such as having to deal with a new website, new money-transfer connections, perhaps a less conveniently located branch or ATM network. But many customers “play that game,” he said.

Ultimately, for the banking industry, it tends to be a zero-sum game as rarely does one bank have a sustained, superior-cost position, branch network, mobile apps, and more to afford to pay more for deposits than other banks while maintaining superior profitability, he said.

Instead of chasing the latest bank “deal” and for funds not needed for near-term expenses, Kolefas recommends putting them into short-term money market funds that invest in short-term government securities such as T-bills offered by major custodians such as Charles Schwab and Fidelity or open an account at Treasury Direct, where you can buy T-bills directly from the U.S. Treasury, he said.

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This story was originally published on Sept. 5, 2023.

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