Rate shoppers. That’s what we call them. These are the people that have zero loyalty to any particular financial institution. They buy a CD or Money Market with the highest bidder. At maturity, they call every bank in town and move money to the new highest bidder. At maturity, again, they call every bank in town and move money again. This process repeats until they die. There is no loyalty, no sticking around, no telling where they’ll go next.
Banks like customers who keep checking accounts with them. Why? Because it means those customers are probably hanging around for a while. Banks like loyalty, but do you know what they like even more than that? Having enough money to meet their loan obligations! After all, the number one way banks make money is to take customer deposits and loan them out for a charge. Banks make money in other ways, but loaning money is the main driver of income.
In order to attract customer deposits, banks need to pay some interest on those dollars(but not in all cases). As of this writing, the average CD in my town is paying between 4-5% APY, but the lowest loan rate you can find is on a HELOC charging 8.5% APR. The difference between the lower CD APY and the higher HELOC APR is the income that the bank makes. It’s not a bad thing—it’s business. It’s what allows the banks to be available for you to use them. Without this system, there are no banks.
Now, banks need the difference between the APY and APR to be high enough to turn a profit after expenses. That means that a difference of 1-2% between those two numbers may not cut it. It’s also important to know that banks can’t simply create a loan using numbers on a computer. There must be actual deposits backing up the loan. If a bank has way too much money on deposits that aren’t turning a profit, they might offer loans at a lower rate than the competition to try and get some type of income generated off the money. Think of it like owning a rental car company. If all of your rental cars are in your parking lot and not out on the road with customers, you aren’t making any money. If ALL of your cars are rented, you’re maximizing your profits(and perhaps dealing with some upset customers who need a rental).
Let’s say you run a bank and you have $100,000,000 in deposits. Suddenly, loan applications are processed and approved and the total loan need is $150,000,000. Well, you’re short by $50,000,000. So, what do you do? Do you tell certain customers you can’t lend them the money through no fault of their own? Then you open yourself up to possible discrimination complaints. You could borrow money from another bank. This is definitely an option, but it costs a fair amount of interest to pursue this route, and that either eats into your profits or causes a rate increase on your customer loans to offset those costs.
A third option(and the gist of this article), is to try and gain more deposits from new customers. How do you do that? The easiest way is to run a deposit campaign that looks extremely attractive to new potential customers. Here’s an example: Every bank in town is paying between 4-5% on CD money. You decide to offer CD rates at 6-7%. You are higher than everyone else in town by a considerable margin. Rate shoppers go on a frenzy, tell their rate shopping friends, and new deposits start rolling in(hopefully, anyway). The rate shoppers don’t care why you’re paying more—they just know you’re the best rate in town.
As a customer, is this setup always a good thing? Not necessarily. There are a number of factors to consider that I won’t go into detail here. For now, I’ll simply say, If a bank is paying more than everyone else, it means they really need more deposits. Does it mean the bank is about to fold? Not always. It would require further research to find out what’s going on. I’ve worked at two banks where a deposit campaign kicked off and the main reason behind both was that the commercial lending team was performing extremely well, and the banks needed money to fund all the new loan applicants pouring in. Were the banks about to fold? Not at all. They simply needed to fund the loans. If money didn’t arrive then the bank would turn away loan applicants to offset the lack of deposits. Most banks would love to fund all the new loans that come through. However, without the right amount of deposits, that simply can’t happen. Again, this isn’t a matter of typing numbers on a screen and hoping it magically works out for everyone. DOLLARS MUST BACK THE LOANS.
Should you, as the customer, be worried if you’re in with the highest paying bank in town and you are finding out this information for the first time? Probably not. The last thing that needs to happen is a run on the bank. Most of the news reporting on banks that fold are a direct result of a run on the bank(at least the biggest reason for the bank folding, though never the only reason).
My point here is to make the following suggestion to you if you are a rate shopper and you spot a rate higher than everyone else’s: do some further investigation. Don’t jump on it just because it’s the best rate in town. Also, if the rate is .25% higher than everyone else, you’re probably fine. If it’s 1% or more than everyone else, investigate. Spread your money around and don’t put it all in the bank that’s paying more than everyone. At the very least, you need to ask the banker, “Why is your bank paying more than everyone else? Are you short on deposits?”
Bottom line: A bank paying a rate WAY higher than everyone else is not always a good thing!
