Ten Likely Scenarios for Rising Deposit Rates

The question about rising deposit rates is not “if” but when and to what degree they will rise. The timing of the rise in rates is relatively easy to project because rates are dependent on economic conditions. From a macro perspective, we are likely to see gradual and sustained improvement in the economy in 2014, provided, of course, that no unexpected or highly unlikely event occurs.

Among the many signs of improvement in the economy, I will mention just one significant factor that is very likely to impact rates. Personal consumption, which makes up about 70% of gross domestic product (GDP), gradually improved throughout 2013. In the first quarter of 2013, it increased 1.1% over the previous quarter, 2.5% in the second quarter and 4.1% in the third quarter. Simply put, this means that consumers are spending much more, which leads to an increase in economic activities and borrowing.

In the absence of a crystal ball, the only way to develop likely scenarios of rising rates is to analyze previous occurrences and study their behavior. The 10 likely scenarios described below derive from our analysis based on the behavior of deposit rates during the last rising-rate cycle, from July 2003 to July 2007:

1. Once rates start rising this year and beyond, the banking industry will face relatively higher interest expense per-deposit dollar due to the inelasticity of consumer deposits. This means that in order to maintain or increase balances, banks will have to increase rates at a greater pace than the increase in balances.
2. During the rising rate period, the largest percentage gain in deposit balances is likely to be in money market accounts (MMDA) while the largest percentage decrease in balances is likely to be in checking accounts.
3. Rates of term accounts are projected to increase in a general linear pattern with minor hiccups, which is easier to project and budget.
4. Rates of liquid accounts are projected to increase in a general down-curved pattern, which makes it harder to project and budget.
5. The increase in rates of deposit products is going to be moderate, gradual and volatile, which will require constant monitoring of the competitive set.
6. Deposit rates are not likely to exhibit big jumps month over month.
7. Whether rates increase in a general linear or curved pattern, rates of all deposit products are likely to fluctuate throughout the rising-rate period.
8. Expect national average rate increases to range from one-half to one basis point per month per product. There will be noticeable variations among the regions.
9. Predictors of rising deposit rates vary by product and include the Fed fund effective rate, the 3-month and the 6-month LIBOR rates.
10. Since the starting point of the rate increases, i.e. current rates, is so low, it will take much longer for deposit rates to reach their pre-recession level.

The above scenarios should serve as a roadmap for rising rates. Institutions should start budgeting higher interest expense and plan for a shift in product balances in accordance with the complete analysis. Not being prepared for rising rates is no longer an option.

Mr. Geller is the executive vice president of San Anselmo, Calif.-based Market Rates Insight, which provides competitive research and analytics to financial institutions. He can be reached at [email protected].