Online Banks Gain U.S. Deposit Share as Branch Banks Keep Rates Low

Tuesday, February 27, 2018 / 08:20 AM / Fitch Ratings 

U.S. retail deposit growth for the largest online banks has outpaced that of traditional branch-based banks over the course of the Federal Reserve's (Fed) five interest rate increases since December 2015, according to a new report from Fitch Ratings on deposits in the digital age. Despite online banks' recent progress, however, Fitch believes the trend could stall if traditional banks initiate more meaningful rate increases on savings accounts and CDs as the Fed implements further interest rate increases. 

Contrary to expectations, the Fed's tightening cycle thus far has accelerated growth in the deposits of online banks as the gap between interest rates offered by online banks and traditional banks has widened. Over the past five years (through 3Q17), Fitch's cohort of eight online banks grew deposits at a compound annual growth rate (CAGR) of 9.7% compared to an overall U.S. deposit CAGR of 5.0%. 

"So far, deposit betas have been lower than expected for both online and traditional banks, but the betas for online banks have started to move up more significantly in the past few months after virtually no movement following the first couple of rate hikes," said Michael Taiano, Director, Fitch. 

From the end of October 2017 through the end of January 2018, the online banks that Fitch tracks (excluding Capital One, for which complete information was not publicly available) increased their rates on savings and money market accounts by 21 bps on average, implying a deposit beta of 86%. Fitch defines deposit beta as the percent of a change in the Fed Funds rate that is passed through in the form of increases in deposit rates. 

While the agency's view will continue to evolve as it observes online deposits' relative performance through an interest rate cycle, Fitch has historically considered online bank deposits to be less stable and more volatile in terms of cost than deposits at traditional banks. However, from a rating perspective, Fitch views the strong growth in online bank deposits favorably as it has lessened online banks' reliance on wholesale funding, which tends to be less stable and more costly, particularly during periods of stress. 

Traditional bank deposits tend to be stickier than online bank deposits given the higher proportion of checking accounts at traditional banks, versus online banks which offer more savings accounts, certificates of deposit and brokered deposits. Still, the ease with which customers can move money between online accounts increases the likelihood that customers will pursue the highest rates available, causing greater risk of decay in traditional banks' deposit balances. 

Longer-term, online banks may also stand to benefit more from generational shifts, with the Millennial generation now larger than the Baby Boomer generation. Millennials' familiarity and comfort with using the internet and mobile phone apps may result in a greater willingness to transfer funds held at traditional banks to online banks, particularly if the pricing gap remains wide. 

"We may see a convergence of pricing of traditional and online deposits as demographics shift towards the Millennial generation," added Taiano. 

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