How banks decide what your savings are worth: Part 1

Post by Dave Tyrer – COO

Competitive pressures

I spent a lot of time on the road over summer — driving between the golden triangle of Auckland, Hamilton and Tauranga — which meant I sampled fuel prices all over the place.

No matter where you went, Gull was by far the cheapest. At Gull Hampton Downs, just off the Waikato Expressway, prices of $2.37 per litre for Unleaded 91 had queues of cars lined up three deep. Just down the road at BP, it was $2.60 per litre. And then some of the bigger brands in Auckland were charging $2.76 per litre — including the fuel tax ($0.115 per litre), and after faffing around to get the discounts they all offer.

The product (petrol) is broadly the same wherever you go, right? So that difference comes down to factors like convenience, facilities, and other direct costs.

It might cost more to run a fuel retailer in Greenlane, Auckland than one at Hampton Downs — but is it so much more that they can justify charging an extra $0.30 per litre, after accounting for the fuel tax? On a 50-litre tank, that’s a $15 difference!

My point is that, even though you can’t negotiate on price at the individual fuel outlet, competition means it can really pay to shop around.

And it’s the same deal when it comes to getting the best interest rate on your savings.

Here are a few things to think consider when choosing how to manage your money.

Transaction accounts

By and large with transaction accounts, banks charge relatively low fees and don’t pay interest on account balances.

In my opinion, compared with 20 years ago, transaction accounts these days offer pretty good value, especially with the flexibility you get with cards, apps, and online banking tools.

The obvious downside here is the “no interest” bit. The banks won’t sting you with big fees, but they’ll keep the interest thanks very much. This puts the onus on you to make sure you’ve never got more than you need in your transaction account. I despair at my mum, who’s not great at this.

In recent years, we’ve seen new non-bank providers starting to have an impact on this space. Booster have recently launched Savvy, a cash-based managed fund which offers debit card and bill payments features, and (best of all) currently pays 5.00% p.a. interest. Dosh is another that provides some pretty cool transaction account features.

Nimble competitors will become more visible over time, somewhat helped by the move towards open banking over the next few years.

Note that Squirrel does not offer transaction account services.

Savings accounts

Competition in this space feels like it’s been pretty weak over the last 20 years — and the banks have got away with some pretty rubbish pricing as a result.

Banks price their savings interest rates based on the shorter-term part of the wholesale interest rate curve. Each bank has its own nuances, but mostly the margin they’ll be paying attention to is the difference between the rate they pay you and the 90-day wholesale rate.

On average in the market, banks currently pay 3.67% p.a. to their savings account customers*, so they’re making a margin of ~2.00% on average. That’s pretty solid. And I’m probably understating it once you consider that they lend some of that money out again, growing their margin in the process.

The fees they charge on savings products are also a bit ho-hum, particularly penalty fees when it comes to the bonus saver type accounts. Be very wary of these, it’s a pretty tenuous argument to say they’re a ‘disincentive to withdraw’. 

The other thing that really gets my blood boiling about bank savings accounts is the practice of “grandfathering” products. I won’t get into the nitty gritty of it here — you can read up more in this article — but if you have a grandfathered product, the banks are likely milking you dry. And you need to do something about it, ASAP.

One notable exception has probably been the introduction of ‘Notice Saver’ products, which have been a welcome addition for many people. And provided you can find a way to manage your cashflow around the various notice periods, they can work well.

The good news is that competition has really started to heat up in this part of the market of late. In the last 12 months, three non-banks — Dosh, Sharesies and Squirrel (with our On-Call Account) — have all launched savings options that offer better interest rates and features than the banks.

Each of these providers holds your funds on trust in a dedicated bank account with a major retail bank. So, it’s not being invested anywhere — it’s essentially being held for safe-keeping, but with a far better rate of return.

The Booster Savvy account is another option that could work as a savings account. The proposition here differs slightly in that it’s a managed fund, but it invests in ‘cash and cash equivalents’. Normally that’s code for ‘we put the money in a bank account(s)’.

For anyone with a bank saving account, it could be worth doing some due diligence around what your current account offers — looking at stuff like the conditions to earn interest, interest rates, and fees. We regularly update our bank savings account comparison, to help with that process.

I suspect you’ll find you’d be better off with one of the new players instead, with virtually no change in the underlying risk.

* Source: RBNZ statistics table B7.

Term investments

Banks work pretty hard on pricing their term investments. At the highest level, they’re setting the rates relative to the wholesale curve, and then overlaying a range of factors like:

• The volume of lending, and term investments, it has coming up for maturity soon;
• The cost of wholesale funding; and
• Where competitors are pricing.

Banks can be very strategic about how they price term investments special rates, and move those around, in order to maximise profits. And they’re happy to benefit from customers who don’t shop around, or who simply accept the first rate they’re offered.

Of course, there’s a value exchange going on here, so these comments are arguably a little unfair. But back to the petrol analogy, shopping around will almost certainly get you a better rate, reducing your bank’s profit and/or forcing it to become more competitive.

Looking beyond directly negotiating with the bank, there are a few other options out there to be considered as well.

With Squirrel’s Term Investments, there’s no rate negotiation. We believe every dollar has the same value, whether you’re investing $100 or $1million — so everyone gets the same rate. I’ve written about transparency in the past if you’re interested, comparing Squirrel Term investment features to banks here.

InvestNow has a Term Investment service where they invest with the banks on your behalf. You can choose from ANZ, BNZ, SBS, Heartland, and a few others too. The benefit of this service is that you don’t have to sign-up with and shift money around the individual banks, and because they’re investing lots of money, they get pretty good rates. Just sign-up with InvestNow and direct your term investments to the best priced bank each time you have an investment maturing.

I suspect we’ll see further innovation in this part of the market over the next few years. The government’s ‘Deposit Compensation Scheme’ being introduced by the RBNZ will also introduce other competitive pressures and interesting opportunities into the market.

How do banks set term investment rates, anyway? Find out in Part 2 of this article, here. 

The opinions expressed in this article should not be taken as financial advice, or a recommendation of any financial product. Squirrel shall not be liable or responsible for any information, omissions, or errors present. Any commentary provided are the personal views of the author and are not necessarily representative of the views and opinions of Squirrel. We recommend seeking professional investment and/or mortgage advice before taking any action.

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