Why Are Interest Rates So Low on Savings Accounts?

Savings accounts are a common financial tool where individuals can securely store their money and earn a small return over time. This return, known as interest, is a percentage paid by the financial institution for the use of the deposited funds. While these accounts offer a safe place for funds, many people observe that the interest rates offered on savings deposits are often quite modest. This observation frequently prompts questions about the underlying economic and operational reasons for such low returns on saved money.

Central Bank Monetary Policy

A country’s central bank plays a fundamental role in influencing the broader interest rate environment. In the United States, the Federal Reserve, often called “the Fed,” sets monetary policy with goals such as maintaining price stability and maximizing employment. A primary tool it uses is setting a target range for the federal funds rate, which is the interest rate at which banks lend money to one another overnight to meet reserve requirements.

Changes in this benchmark rate create a ripple effect throughout the entire financial system. When the Federal Reserve lowers the federal funds rate, it becomes cheaper for banks to borrow, influencing the rates they offer to consumers and businesses. This reduction translates into lower annual percentage yields (APYs) on savings products, as banks adjust deposit rates to maintain profitability. Conversely, when the Fed raises this rate, banks increase savings account interest rates to attract deposits. The Fed also influences liquidity through quantitative easing, injecting money into the financial system and contributing to a low-interest rate environment by making funds more abundant.

Broader Economic Factors

Beyond direct central bank actions, economic forces contribute to the prevailing low interest rates on savings accounts. One factor is the level of inflation, which represents the rate at which the general prices for goods and services increase over time, reducing purchasing power. When inflation is low, there is less pressure on central banks to raise interest rates, and less incentive for banks to offer higher rates to depositors to compensate for eroding purchasing power. If the interest rate earned on savings is lower than the inflation rate, the real value of money held in savings effectively decreases over time, despite a nominal increase in the account balance.

Economic growth and the demand for loans also directly impact savings rates. During periods of slow economic growth or reduced consumer and business demand for borrowing, banks have less need to attract large volumes of deposits. This reduced demand for funds means banks have less incentive to compete for deposits by offering higher interest rates. An abundance of money circulating in the financial system, known as high liquidity, can reduce the “price” of money, leading to lower interest rates.

Bank Business Models

The operational structure and competitive landscape of financial institutions influence the interest rates offered on savings accounts. Banks primarily generate revenue by borrowing money from depositors at a lower interest rate and lending it out to borrowers at a higher rate, profiting from the interest rate spread. This difference is known as the net interest margin. When overall lending rates are low, often influenced by central bank policy and economic conditions, the margin banks can earn from lending is compressed. This compression limits how much they can afford to pay out to depositors while maintaining profitability.

The competitive environment also plays a role, particularly with the rise of online-only banks. These institutions operate with lower overhead costs compared to traditional brick-and-mortar banks, as they do not maintain extensive physical branch networks. This reduced operational expense allows online banks to offer higher interest rates on savings accounts and charge fewer fees, creating competitive pressure. However, traditional banks have diverse funding sources beyond individual consumer deposits, such as wholesale funding markets or corporate deposits. Relying on these alternative sources can reduce a bank’s dependency on attracting consumer deposits through high savings rates, further contributing to the lower rates observed at many institutions.