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How do deposit rates react to monetary policy? – Economy of Liberty Street

Editor’s note: When this article was first published, the legend entries for the first chart were transposed; caption corrected (November 21, 9:45 a.m.)

When the Federal Open Market Committee (FOMC) wants to raise the federal funds rate target range, it raises interest on reserve balances (IORB) paid to banks, the primary credit rate offered to banks, and the allotment rate. paid to participants. who invest in the overnight repo market (ON RRP) to keep the fed funds rate within the target range (see Economy of Liberty Street posts on this topic). When these rates change, market participants react by adjusting the valuation of financial products, an important category of which is deposits. Understanding how deposit conditions adjust to changes in policy rates is important for understanding the impact of monetary policy more broadly. In this article, we assess the pass-through from the federal funds rate to deposit rates (i.e., deposit betas) over recent interest rate cycles and discuss the factors that affect deposit rates. .

Deposit beta

Deposits are an $18 trillion product category that is essential to the funding structure of banks and a key source of savings for households and businesses. The extent to which changes in the target federal funds rate affect deposits is important for bank funding, monetary policy transmission and depositor finances. Deposit beta is the portion of a change in the federal funds rate that is passed through to deposit rates. For example, if the target federal funds rate is raised by 50 basis points and in response a bank raises its deposit rate by 25 basis points, the deposit beta is 50%. In a rising rate environment like the one we currently find ourselves in, low deposit betas boost bank earnings but limit payouts to depositors.

We estimate the evolution of deposit betas using Bank Holding Company (BHC) regulatory deposit data (FR Y-9C). To derive the annualized rates paid on deposits, we add up all BHCs and scale the interest expense paid on deposits by total interest-bearing deposits (IB) for each quarter. Although we focus on the rates paid on IB deposits, including non-interest bearing accounts does not affect our overall conclusions. We focus on deposits at the industry level given our interest in the overall impact of monetary policy on deposit rates.

Deposit Rate and Federal Funds Rate

Sources: FR Y-9C; H.15; and the authors’ calculations.

The chart above shows the trajectory of deposit rates and the average federal funds rate over time. Deposit rates follow the federal funds rate but are generally lower, especially when the federal funds rate is high.

Previous research has shown that betas are lower when the fed funds rate rises than when it falls; therefore, we focus our analysis on periods of rising rates. We consider the current cycle as well as three cycles of tightening over the past thirty years: 1994:Q1-1995:Q2, 2004:Q3-2007:Q2 and 2015:Q4-2019:Q2. In the chart below, we calculate cumulative beta as the cumulative change in deposit rates relative to the cumulative change in the fed funds rate over multiple tightening cycles.

Accumulated betas of deposits over crunch cycles

Liberty Street Economics chart showing deposit betas calculated over each interest rate tightening cycle over the past thirty years.
Sources: FR Y-9C; H.15; and the authors’ calculations.

As the chart shows, deposit betas started to rise in the 2004 rate cycle and peaked at a cumulative beta approaching 60%, whereas in the post-financial crisis cycle betas start near zero and ultimately never exceeded 40%. The 1990s appears to be an in-between example with no response in the early quarters, but with a rapid and growing beta towards the end of the crunch cycle. Peak betas have dropped by around 30%, a significant decrease since the 2000s.

The role of the supply of deposits

Changes in deposit betas since the 1990s are occurring alongside significant changes in the monetary policy regime and financial conditions, particularly since the global financial crisis (GFC). In particular, deposits have increased significantly as a source of funding for the banking sector. One of the reasons banks may be reluctant to raise deposit rates is that they have more deposits than they actually need, so they are willing to allow depositors to seek better rates elsewhere. .

We consider two measures of deposit supply to help explain the evolution of betas over the past decades. Since the financial crisis, deposits have grown steadily as a proportion of bank assets, especially invested assets such as loans. In the chart below, we plot the ratio of BHC loans to deposits and loans plus securities held to maturity (HTM) to deposits. The loan to deposit ratio is often referenced by the industry as a measure of investment versus funding, but since the financial crisis, HTM securities have risen significantly in response to regulatory changes and are unlikely to be sold, especially in a rising rate environment, so we include them in loans.

Lending to deposit funding has declined since 2007 and is particularly low following the COVID recession. The patterns reflect the growth in deposit funding during the period when the federal funds rate is close to zero. These ratios were also low at the start of the 1994 rate cycle. Therefore, the level of deposits appears to be roughly correlated with the responsiveness of deposit rates to increases in fed funds, i.e. deposit betas ), as shown in the previous graph.

Loan-to-deposit ratios and federal funds rate

Chart from Liberty Street Economics measuring the spread between the average federal funds rate and the deposit rate over time (the deposit spread).
Sources: FR Y-9C; H.15; and the authors’ calculations.

Countering the large amount of deposits are forces that encourage depositors to withdraw and invest elsewhere. One way to measure depositors’ opportunity cost is to look at the spread between the average federal funds rate and the deposit rate over time (the deposit spread). This spread is representative of the gains that depositors are giving up. A larger spread means the opportunity cost of holding deposits is higher, and a smaller (or negative) spread means it is lower. From the banks’ perspective, a higher spread suggests that depositors are more likely to leave the banking sector to seek other investments.

Deposit Spread, Deposit Rate and Federal Funds Rate

Liberty Street Economics chart showing the trajectory of deposit rates and the average federal funds rate over time.
Sources: FR Y-9C; H.15; and the authors’ calculations.

Looking at the chart, we can see that the spread is negative when rates are close to zero (and deposit levels are high) and positive when rates are rising. As a result, after the GFC and before the 1994 tightening, deposits were more attractive to depositors and the supply of deposits was high relative to loans. These periods also correspond to lower initial deposit betas. However, as rates rise, the spread increases, depositors move elsewhere, banks increase their rates, and the cumulative betas of deposits increase.

In addition to the time series, we examined cross-sectional evidence linking these measures of deposit supply to deposit betas across banks. Our results indicate that the loans-plus-HTM securities-to-deposits ratio and the deposit spread are positively correlated with deposit betas.

Take away food

Since the 1990s, the response of deposits to monetary policy has waned. This is explained by the growth of deposits over the post-crisis period compared to investment opportunities. Understanding deposit price dynamics requires thinking about the amounts of various funding sources and the presence (or absence) of competing products. Taken together, current deposit betas are lower and slower given the large supply of deposit funding from banks. However, going forward, the rapidly rising federal funds rate suggests that the deposit spread will be higher than recent rate cycles, prompting depositors to look elsewhere and deposit rates to rise accordingly. .

Alena Kang-Landsberg is a research analyst in the Research and Statistics Group at the Federal Reserve Bank of New York.

Photo: Portrait of Matthew Plosser

Matthew Plosser is a Financial Research Advisor in Banking Studies in the Research and Statistics Group at the Federal Reserve Bank of New York.

How to cite this article:
Alena Kang-Landsberg and Matthew Plosser, “How Do Deposit Rates Respond to Monetary Policy?”, Federal Reserve Bank of New York Economy of Liberty StreetNovember 21, 2022,

The opinions expressed in this article are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

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