How do banks make money?
Of the 94 different industries in the United States, the banking industry is the most profitable, with regional banks' gross profit margins at nearly 100% and net profits at about 30%. The average for other industries is about 36%. In 2023, the banking industry reported a net profit of $256.9 billion.
One of the main ways banks make profits is by borrowing money from depositors at a certain interest rate and then lending that money to borrowers at a higher interest rate. Banks make profits from the difference between the two interest rates.
For example, a bank borrows money from you by putting it in a savings account at 0.45% interest, then lends it out as a 30-year loan at 6.87%. The bank's take is 6.42% of the difference. For personal loans and credit cards, the difference could be much higher. The less interest a bank has to pay, the more profit it can make, so it makes sense to keep interest rates as low as possible.
Personal Savings Rate
Now, banks don't have to worry about competing for customers' funds. Since the pandemic began, the amount of cash held by U.S. banks has been at near-record levels. With Americans putting money into their savings, banks have little incentive to raise savings rates.
Prior to the pandemic, commercial banks had total cash assets of $1.8 trillion. Cash assets rose to more than $4.1 trillion in December 2021, more than double the total in February 2020. Cash assets have declined slightly from their pandemic peak to about $3.47 trillion, but are still near record levels.
While banks are sitting on piles of cash due to the pandemic, lending has slowed significantly. U.S. banks' loan-to-deposit ratios have fallen sharply since the pandemic began, hitting 58% in the second quarter of 2021, the lowest level on record, according to an S&P Global Market Intelligence database that stretches back to 2003.
Deposit levels have risen since then, hovering around 64% of 2023, but lower than 72.4% in the fourth quarter of 2019, before the pandemic. That means banks are sitting on more deposits than ever before, and many have little incentive to raise interest rates to attract capital.
Read more: How to calculate interest rates on savings accounts
Banks don't need your money
Banks also adjust their savings rate based on the supply and demand for loans and deposits, and the policies of the Federal Reserve. If supply is ample and people are saving a lot, banks don't have to pay as much interest. If people aren't saving as much and banks need more money to lend out, banks will raise their savings rate to attract more depositors.
When banks need money, they raise savings rates to attract customers. Banks lose money by charging higher interest rates, so they keep them low to maximize their profits. Even though the federal funds rate has increased to its highest in 20 years, banks continue to keep savings rates low because they have more money than they need.
High inflation typically leads to higher interest rates, which in turn drives up savings rates as banks compete to attract more deposits. If banks want fewer deposits, they will lower interest rates. Many of the larger banks are currently well capitalized and are not actively seeking additional deposits. Interest rates will remain low until demand for loans increases and banks see a need for more deposits.
How to find a better rate
Although interest rates on savings accounts are low, it's important to shop around to find the best rate. To attract depositors, smaller financial institutions offer higher interest rates to their customers.
The main reason small banks can offer higher yields is because they operate on a smaller scale. Credit unions and online-only banks often offer higher interest rates because they don't have the large overhead costs of larger brick-and-mortar banks.
Plus, there's no pressure to constantly impress shareholders.
Online banks and credit unions may offer higher interest rates. CDs and money market accounts may also offer higher interest rates than savings accounts. These are also options to consider if you're looking for a better rate.