High deposit interest rates – a warning sign

When shopping most of us want to get the most we can for our money and that applies to the interest on our savings accounts.

However, a word of warning.  Sometimes when financial intermediaries are having problems they try to hang on by offering a higher interest rate on deposits.  This attracts more deposits which may help in the short-term but   reduces their margin between the cost of deposits and what they can charge for loans.  This only  adds  to their problems.

money_back_stickerThere have been cases of financial institutions doing this but it wasn’t enough to save them.  Some people who thought they were being smart, including some municipal treasurers, have been caught.  While some deposits are covered by deposit insurance it is probably better to stay away from troubled banks.  These days the interest rates being paid on savings are so low that most of us are probably just as well off to go with safety rather than returns.

This note was prompted by this article about some Canadians who are looking for the best returns on their savings.  I don’t want to say that every firm offering a higher interest rate is in trouble, but it can be a warning sign.  At least ask questions.


One Response

  1. I heartily concur with this comment.

    Three points you ought to remember.

    1. Any difference between the interest rate you are offered and a ‘risk free’ investment, such as a US government bond, is a ‘risk premium’, a sort of insurance premium. In the economic sense it is not interest at all. Always remember that.

    2. Economic analysis over long periods of time show that this ‘risk premium’ is nearly always insufficient to pay for the risk. If it was an insurance premium and you were an insurance company, your insurance company would be a loser.

    3. Finally, the experience has beeen that when interest rates are very low, people chase higher interest, including higher risk premiums and higher risk. But under recession conditions risks go up while paradoxically risk premiums go down.

    Moral. In a recession, invest in something else than interest bearing investments. Or US government bonds only. ‘something else’ may also have higher risk, so it will take a lot of hard work to work out what to do. But this is a different story. So stick to government bonds. But remember inflation is currently very low or non-existent, so you don’t need to worry about that….

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