What Is The Relationship Between Fed Funds Rate and Interest Rates On Bank Savings Accounts?

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With all this talk about the Fed Funds rate drop, a lot of people are wondering what it means for consumer rates like savings accounts, credit card APRs, and mortgage rates. Here, I wanted to explore the savings account relationship. First, some quick definitions:

What is the Fed Funds Rate?
With our current system of fractional-reserve banking, US banks only have to keep a certain amount of money reserved at all times – Currently, it’s only 10% of checking account deposits and nothing (!) on time deposits like savings accounts. Banks usually try to keep as close to this minimum as possible, so that they can lend out the rest at higher interest rates and make that juicy profit.

In order to stay as close as possible, banks often lend money to each other overnight as needed. One bank may have extra in reserves, while another may temporarily not have enough, and this way it’s win-win. The target interest rate for this is the Fed Funds Rate (FFR).

What is the Fed Discount Rate?
This is the exact interest rate at which banks can directly borrow from the Federal Reserve. This is usually a last resort, as such loans are an indication of financial weakness and subject to audit.

What is the relationship between the Fed Funds Rate and interest rates on high-yield savings accounts?
This is just my own speculation, but I would imagine that banks would not want to offer significantly more than the Fed Funds rate. Why would you pay 6% interest out to individuals when you could just pay 5% to another bank? Still, I doubt that banks can borrow an unlimited amount of money via other other banks, so they may be willing to pay a bit more than the FFR if they have the ability to make a profit. Finally, they may just be operating at a temporary loss in order to grab some deposits that hopefully will stay later from branding or just convenience (*cough* FNBO Direct *cough*).

Here is a historical chart of the Fed Funds Rate versus the APY paid by online banks Capital One 360 and Emigrant Direct. I chose these two because they have (1) been around longer than others, and (2) are online and as such should be operating with the thinnest margins. The data points for ING should be close, but not perfectly accurate, as I used Archive.org at 2-month intervals for rate info not available in my own archives.


You can definitely see some correlation, but it’s not perfect. It looks like ING was more aggressive in 2002-2004, and then gradually become satisfied with fatter margins. Emigrant seems to be following the curve closely, which would indicate an interest rate drop soon. So if you want to predict the interest rate of your own bank, not only do you want to look at the FFR, but also the bank’s historical margins and whether they are looking to gain (or simply defend) market-share.

A little birdie told me to expect an FNBO Direct rate definitely under 5% after 9/28. I’m just writing this here to see if it turns out to be correct.

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  1. GMAC dropped their rate from 5.3% APY to 4.9% APY after the fed cut the fed funds rate by .5%.

  2. Beauty! I did a graph like this (though not as complete… must investigate Archive.org) before I chose to put my money in a MM fund at Vanguard. I then calculated the area under the curves and went for the highest one… does that sound correct?

  3. Thanks again, Jonathan!

    I am still in utter dismay at Bernanke’s move. If he were a relative comin’ over to my house, this Thanksgiving, his turkey might have a little extra sumfin, sumfin in it for pullin’ a stunt like that. 😉

    ********P.S………………I think a good next blog would be………

    “GUESS WHERE FNBO’S RATE WILL GO AFTER 9/28” (and include a poll w/ a handful of interest rates a few tenths above & below 5%)

  4. I’m thinking FNBO at 5.05% with a 3rd due diligence e-mail to annoy everybody 🙂

  5. That’s super… Thank you so much. I bet Emigrant decided to stay around for 2 weeks after it attracted some new customers on a temporary margin.

  6. Hey all,
    The blog is great by the way! This really has nothing to do with the current posting about the interest rates, except that I am trying to pull out some cash from my new credit card. I cant exactly figure out how the whole balance tranfer thing works. I am trying to get the cash in hand and they keep telling me that if I do the “Send a check” option that I will be charged the ridiculous standard rate”. The 0% only works for balance tranfers. I was wondering if anyone would be able to give me some insight into how I can acutally access the cash. P.S. the offer I just got was from U.S bank. It has 0% int. on balance tranfers and no fees! Check it out. I didnt get an offer in the mail but I did call them and ask. Good luck. I would really appreciate any help anyone would be able to offer.

  7. Send the check to your other credit card account and get a refund check of the excess amount.

  8. Will they send me the entire check if I do not have a balance at the other credit card? -Thanks for the reply

  9. Yeah, I’m thinking the half point was a little steep. Do you think it was because of Wall street pressure or because they’re trying to curtail a possible recession in the future?

  10. I, personally, think that the .25% was too highly expected.

    If you simply do what they expect, then you really accomplish nothing, thus Bernanke’s decision to “cut to the chase” (so to speak) and take it to .5% right away.

    I would’ve thrown a real shocker the other way & not cut rates AT ALL!!!!!!!!!

    Make this flippin’ country CLIMB its way out of trouble for once!!!!!!!!

  11. I see gmacbank has cut their rates. But EmigrantDirect and Wamu are still at 5.05% apy. I would like to move my funds to either one but both going to stay at that rate?

    This is the question lots of people want to know the answer to. An optimist in me would like to say 5.25%. If they drop below 5.05% that HSBC still offers, I’ll transfer my money there.

  13. I Love HSBC, I’ll never leave them, unless they cut their savings rate. That’s the shallow truth of finance, and I’ll admit it.

  14. Has anyone noticed Countrywide savingslink is at 5.5%? It is a bank and FDIC insured.

  15. Bankdeals blog says FNBO will drop to 5.05 after their promotion ends on Friday.

  16. Yes. HSBC Still offers 5.05. Howz is Flushing’s i Go Banking?

  17. FBNO sent an email today saying it will be 5.05%. So much for your little birdie, kudos to Bankdeals.

    Good job on keeping yourself accountable and not billing up a rumor as fact!

  18. Does anyone have any experience with UFB Direct or iGObanking.com? Meaning, do either of them do faster transfers than FNBO?

    Also, in regards to the EverBank 6.0% apy intro… is it still around? and if so, is the minimum still 1500?

  19. I just got an email from HSBC, the Online Saving was cut to 4.5% and the Online Payment Account held steady at 2.5%.

  20. Phil,

    Man, you’re fast. I just came here to post that same info. Got the mail about 5 minutes ago. Bummer.

  21. A. Skywatcher says

    I got the same notice from HSBC as the previous two posters. As I look at rates tonight on Bankrate.com I notice that rates at many banks are dropping like stones and I am apprehensive about where and when the rest of them are going to go. Help Jonathan, where do we all go now if we still want to rate-chase and will not be satisfied with 4.5%!!??

  22. Cash advances are all very expensive, costing 20% a year. When you go out and buy something on a card. The credit card company get 2% from merchant, when you pull cash out of your credit card. They got nothing, so they charge you 20%.

    I recommend Discover Open road, I got it for a year, 5% cash back on my gas, 0% Interest rate for a year, and only 10.99% after that.
    I also get 1 % cash back on my other purchases. I love it

    I had a bank-issue credit card, no reward, no rebate, no nothing, it sucks, and 17.99% interest rate.

  23. Having just read The Orange Code, this chart is interesting and makes perfect sense. ING started a bank with Savings accounts unlike any other bank which also needs to take on Mortgages to pay out interest to savings accounts. Their margins are typically 2%, ING’s have been around 1% as their business model affords them lower costs than traditional banks. They achieved profitability after a year or two and then continue to follow the market rates for both savings and mortgages to keep that 1% operating margin. With such non-constant rates lately, keeping that margin is probably pretty difficult and I’m sure they are hedging their bets a bit with this low Savings interest rate. We will see when they report their quarterly earnings though.

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