The Federal Reserve's increases to a key interest rate to tame runaway inflation also have had an affect on adjustable mortgages, auto loans and credit cards.
By raising the Federal Funds Rate — the interest rate at which banks and other depository institutions lend money to each other on an overnight basis — the Fed is controlling the supply of available funds, inflation and other interest rates. In theory, raising the rate makes it more expensive to borrow, which lowers the supply of available money, which in turn increases the short-term interest rates and helps keep inflation in check. Lowering the rate has the opposite effect, bringing short-term interest rates down.
"This means the Fed has recognized the large increase in inflation and is trying to take actions to reduce the inflationary pressure," said Ken Cyree, dean of the University of Mississippi School of Business Administration and the Frank R. Day/Mississippi Bankers Association Chair of Banking. "These increases will impact banks in several ways. On the positive side, the increase in rates will allow banks to earn larger spreads between lending and deposit rates on the new loans they make. Savers will earn more in savings and CD accounts, but these rates are still historically low, below 1% for most savings accounts, for example.
The Fed has raised the Federal Funds Rate four times this year including 75 basis points (.75%) in June and July, moving benchmark overnight borrowing rate is up to a range of 2.25%-2.5%.
Gordon Fellows, president of the Mississippi Bankers Association, said with banks raising rates it's important for borrowers to review the terms of the credit agreements and to be in close communication with their lenders about potential changes to what they pay on their loans.
"Bankers around the state are working closely with borrowers and depositors to assess individual needs to help their customers deal with the challenges that this high inflation environment is creating," he said.
But higher rates also put pressure on banks, which will be challenged with lower demand for refinancing and new residential loans as rates have risen, Cyree said.
"We are starting to see those impacts in the markets. The most recent data for investments in mutual funds shows investors are liquidating these funds at a faster pace this year than any time since 2020. Mutual fund liquidations are a function of a poorly performing stock market and better rates for investors elsewhere," he said.
Investors may look into CDs, or Certificates of Deposit, which a higher rate of return than traditional savings accounts, but since there are high levels of deposits in banks, these rates are likely not to go up much in the short run.
Said Cyree, "Interest rates are not keeping pace with inflation and the rapid increase in prices, but if inflation moderates then the gap between inflation and bank rates will decline. One strategy in investing in bank CDs is to use a shorter maturity and then roll over the CD into higher rates later. However, the investor should review this decision carefully since there is no guarantee rates will rise later and therefore the investor should at least consider mid-term CDs if the rate is attractive."
Fellows said that while interest rates that banks pay customers for deposits are starting to tick up, there are supply and demand forces that are holding deposit rates down from what those rates might otherwise be.
"As part of their core function, banks use deposits to fund the loans they make. So of course the interest rates banks pay on CDs and other deposit products are impacted by the Fed fund rate, but those deposit rates are also impacted by the bank’s demand for deposits to fund loan growth," he said.
Fellow added that an unexpected impact of all of the COVID-related stimulus passed over the last two years is that bank deposits are at very high levels. From June 2019 to June 2021, according to the FDIC, total money on deposit in Mississippi bank accounts increased from $55 billion to $71 billion
"Many of the individual stimulus checks that folks received, PPP loans, state and local grants, and other types of pandemic stimulus were deposited in local banks," Fellows said. "This money continues to move around the state as people buy goods and services, and much of it remains in the banking system. Keeping that money in the state’s banking system is a really good thing, but it does mean that at a macro level, banks have less need for deposits than they probably would in a normal environment, and that loan growth is going to have to catch up to deposit growth before the rates banks pay for deposits begin to approach maximum levels.
"We’re beginning to see bank demand for deposits pick up as we get further away from 2020, but so far this dynamic has kept the interest rates banks pay on deposits lower than they otherwise might be in an increasing interest rate environment."