An overview of savings rates

This short article seeks to help explain the different factors that impact how banks set their savings rates and how that feeds through into net interest margin and profitability. It provides a summary overview of these topics rather than being an in-depth analysis.

The importance of savings

A recent survey by the Money and Pensions Service found that a quarter of UK adults have less than £100 in savings[1]. As a result, banks are committed to encouraging people to save where they can, so as to give them a cash buffer to help deal with any unexpected shocks to their finances.

How do banks set interest rates?

The core function of a bank is to take in deposits and then lend out that money, for instance through personal loans, mortgages or business lending. Any margin made on the difference between rates offered to savers and those charged to borrowers supports banks’ operational costs, provisions for bad debts and delivering a return to shareholders.

Banks take a number of factors into account when determining the interest rate paid to savers or by borrowers. The Bank of England’s official ‘Bank Rate’ is only one factor. Other factors include the cost of raising funds, both in the retail and wholesale markets, capital and liquidity requirements, customer and regulatory expectations and the fact not all borrowers will fully repay loans.

There is a wide range of cash savings accounts on the market and the interest rates offered are set by individual banks in competition with each other. The level of competition in the market is a key factor, alongside the nature of a bank’s own business model and customer strategy.

The level of accessibility and flexibility an account offers also impacts the interest rate – i.e. whether a depositor can have instant access to their money or whether it is locked away for a longer period. Banks will generally pay lower rates of interest on instant access savings products and higher rates of interest on savings products where customers commit to keeping their savings without withdrawals for an agreed period of time.

There are also a number of regular saver products available that offer a higher rate of interest or loyalty bonus depending on the monthly amount a depositor commits to. These products are designed to encourage customers to start saving and strengthen their financial resilience.

Comparing interest rates

Price comparison websites and best buy tables show what is available in the savings market across different firms and allow customers to compare interest rates and switch to a different bank if they find a product that better suits their needs.

Banks publish information on their websites and in branches showing the current interest rates for their own products.

The market is competitive with a range of fixed and variable rate products available. We would always encourage customers to shop around for the product and interest rate that is suited to their needs, using information and guidance as appropriate.

Savings rates versus mortgage rates

Rates on savings and mortgage products are separate and will move at different times and by different amounts.

One factor is that most mortgage borrowers have opted for fixed rate products (around 80%), meaning any increase in the Bank of England Bank Rate does not lead to any change in their monthly payment until their fixed rate period expires. Customers on a tracker mortgage which is pegged to the current Bank Rate will see their cost of borrowing increase.

In general cash savings rates are not directly linked to Bank Rate, although there are some tracker products on the market.

Net Interest Margin

Banks are commercial organisations and therefore aim to offer the best possible value to customers while also making a profit. That profit enables them to invest and grow their business for the benefit of customers as well as to pay shareholders (including pension funds and insurers) a return on their investment. In addition, it is prudent for banks to maintain a strong liquidity position on their balance sheet and retained profits contribute to this.

Net interest margin (NIM) is a term that describes the difference between the interest income generated by a bank and the amount of interest paid out. It is something investors look at carefully.

Economic conditions over the past decade, including actions taken by the Bank of England to support the UK economy (in particular quantitative easing), led to a significant reduction in interest rates for both savings and loans.

The very low interest rate environment we experienced until the end of 2022 resulted in NIMs being compressed and now rates are increasing. The NIM figures banks are reporting in their financial results are reverting to more typical levels.

Interest rates on both savings and loans being offered by banks are now increasing, reflecting changes in the wider economy and monetary policy.

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