How are the banks behind high yield savings accounts able to pay such high rates? Where does their yield come from? Do they invest in just high yielding treasuries or junk bonds, or other high yielding things?
How are the banks behind high yield savings accounts able to pay such high rates? Where does their yield come from?
The money deposited in the checking accounts, savings accounts, high yield accounts, and CD's is the source of the funds that the bank uses for their loans. The interest they collect from the car loans, personal loans, mortgages, and other loans is the income that they use to pay interest to their depositors. It also pays all their expenses and salaries, are generates a profit.
Do they invest in just high yielding treasuries or junk bonds, or other high yielding things?
If they are paying depositors X percent then they need to charge XX percent for their loans. Banking regulations define how much of their deposits can be turned into loans, and how much has to remain with the central bank, and cash on hand.
Since we are currently coming out of a zero-interest-rate regime you may be wondering how the bank can make money offering 4% on a savings account while getting 2% on the loans it made last year.
The answer is that it doesn't. The bank loses 2% on this deal. It has no choice - it needs the money behind the loans, so it can either get it from your savings account costing 4%, or from the Federal Reserve costing 4.5%, or somewhere in between on the interbank market.
Of course, the bank makes money on the loans it makes this year at 6%, and it also made money last year on last year's 2% loans when it was only paying 0.1% on savings accounts.
A variety of factors
- Some view the interest as a marketing cost. If it costs $x to attract a customer, a bank can either spend that on a flashy marketing campaign with TV ads and direct mailers or it can set interest rates higher than normal and let financial journalists and other middle-men drive the traffic. Since the sort of person that is interested in a high-yield savings account is probably the sort of person that is going to be interested in a mortgage, in investments, and other banking products, it can make financial sense to pay a decent amount to make that person your customer.
- Often, banks offering the highest rates are those with the smallest overheads. It costs money to build and staff a bunch of branches across the country. It costs money to have call centers to deal with customers that want to call in with problems. Internet-only banks (or internet-only divisions of existing banks) can pay more interest than brick-and-mortar banks because they don't have the same sorts of overhead.
- The interest rates they're offering are less than you can get for US treasuries let alone what they can get from lending that money out. Back in the 50's and 60's, bankers were said to use the "3-6-3 rule"-- pay depositors 3%, lend the money out at 6%, and be on the golf course by 3pm. While not entirely fair, the basic idea here is that as long as you've got creditworthy people and businesses that are willing to borrow money at a rate higher than you are paying depositors, your bank has a pretty decent chance to make money. You still have to worry about things like interest rates going up making the assets on your books less valuable (what happened to Silicon Valley Bank) or a bunch of your borrowers suddenly getting caught up in a downturn (what happened in the Savings and Loan crisis back in the 80's). But in general, it's a pretty profitable business to be in.
For the most part interest rates are relative to the fed rate, which is currently at 4.58%. This is the rate at which banks lend each other money and I have not seen any bank offering a savings rate higher than this. If they can pay you 4% for your money and then very easily and fairly safely make 4.5% on that money it's a no brainer. However that isn't the only way banks make money as others have mentioned they issue loans of their own or as you have suggested they invest the money in bonds (also essentially a loan). Short term treasury bonds were up to as high as 5.5% and 30 year t bonds went over 4%. They are both currently down a bit but it's still fairly easy to buy bonds with a greater rate than the interest being offered by savings accounts.
They will have a lot of outstanding loans at lower rates but probably not as many as you might think. Mortgage rates for example hit a low of about 2.67% in 2020 but they were also 5% in 2018 and over 5% anytime prior to 2010. So most banks will likely have a lot of outstanding loans still paying them 5% interest and this is also what they expect for the future. Nobody expects fed rates to stay up for very long so they might be paying 4% interest on savings for a year or two but the loans they issue during that same time will be generating 7-10% interest for the next 20-30 years.
The way a financial institution handles its cash and reserves is a very complex matter and extremely competitive. Its also pretty much impossible to do right but most banks have no choice but to remain competitive and high interest savings accounts and CDs are a way to do that.
The majority of high yield savings accounts are tied to a specific lender with a specific type of investment.
For example, American Express's HYSA will be used to fund American Express credit card balances. Goldman Sachs's Marcus HYSA is invested in Marcus-branded personal loans and GS's credit cards (Apple Card, GM Card). Ally Financial has a range of loan products, but they're heavily into cars (since they were formerly GM's financial arm).
A common factor is these loans have higher interest rates. Credit cards have APR's easily 15-30%, and have the benefit of being variable and tied to the prime rate. Car loans, without the manufacturer subsidy, are 6-10%. These are much higher than 3% fixed-rate 30-year home mortgages that other banks invest in.
The downside is that these are riskier investments, tend to be consumer loans, and they're concentrated with one lender. Depositors should consider what exactly the company loans money for, and what their credit standards are. For example, if gas prices shoot up, car loans may see much higher rates of default, and those repossessed cars will be harder to resell, so a car loan company may be in trouble.
These factors may be less important, however, for people whose deposits are less than the insurance limit.
Other lesser factors include low overheads (no branches) and less liquidity (it takes several days to transfer your money out to a regular bank account, so people tend to leave it in).