UK banks lead global rivals in passing on interest rate benefits to savers

UK banks have handed more of the benefits of interest rate rises to savers than their counterparts in Europe or the US, as politicians, regulators and clients push for a greater share of the haul.

Global banks are coming under pressure to pass on the benefits of higher interest rates to their customers — but lenders in less competitive markets have proved far less generous than others, according to an analysis by rating agency S&P.

“After years of extremely low profitability linked to extremely low rates, banks now have a chance to recover some of their profitability levels from before the global financial crisis,” said Marco Nicolai, an analyst at Jefferies. “They are not keen to give that up straightaway.”

The rapid interest rate hikes by central bankers over the past 18 months to combat the threat of inflation have been a boon for banks, which generate profits from the difference between the rate they pay depositors and what they charge borrowers, known as net interest income.

Analysts estimate the profit margins European banks make from net interest will peak in the third quarter this year.

But while the banks argue that healthier margins are a return to normal business conditions following record low and even negative interest rates, they have faced pressure to share more of the bounty with their customers.

Comparing markets based on the share of the increase in policy rates that banks pass through to the interest rates on deposits — a metric known as deposit beta — shows that customers in countries that began hiking rates sooner have benefited the most so far.

In the UK, the Bank of England began raising rates in December 2021, one of the first major central banks to do so. Since then, it has raised its policy rate from 0.1 per cent to 5 per cent, with investors betting it could jump to 6.5 per cent by next March, the highest level since 1998.

The UK’s biggest banks, meanwhile, have passed on 43 per cent of the benefits to their customers in higher deposits.

“Not only is the UK seven months ahead of the eurozone in the cycle, there is also a higher level of competition, especially with non-banks,” said Nicolas Charnay, an analyst at S&P Global Ratings, explaining why the UK’s deposit beta was among the highest in Europe.

But as Britain is gripped by soaring inflation and surging mortgage rates, politicians, regulators and the Bank of England have demanded banks raise deposit rates even higher for savers.

The chief problem in the UK is that fixed-term mortgage rates are tied to swap rates, which have risen much faster than the BoE policy rate.

“What politicians don’t want to see is much higher mortgage rate pass through compared to savings rates,” said Andrew Coombs, an analysts at Citi.

US banks, meanwhile, passed on 25 per cent of the Fed’s interest rate increases since it began hiking in March 2022 to April this year, with S&P analysts predicting deposit beta to have “increased materially” since then.

Even so, corporate and institutional clients have called on US lenders to increase their deposit rates further. 

US lenders are under more pressure than European peers to pass on the benefits of rising rates to their customers due to the competition within the market, not only between banks, but also with different savings products on offer.

Unlike European banks, which have generally been seeing modest inflows into deposit accounts over the past year, US banks have suffered 5 per cent outflows over the same period, according to Citi.

“One of the biggest differences between European and US banks is the money market flight in the US, where it is much easier to shift money from a bank account to a money market product or even buy Treasuries,” said Coombs.

“That ease of movement is part of the dynamic that explains why US banks are willing to offer higher deposit rates.” 

Across the eurozone, where the European Central Bank began raising rates in July 2022, banks have been slow to pass on the benefits to their customers. The average deposit beta for large eurozone banks in the nine months to April this year was 18 per cent, compared to 36 per cent in the first nine months of the previous period of sustained rising rates in 2005-8.

Analysts said one of the main reasons for the delay was the speed with which policy rates had risen this time compared to 2005.

French lenders are among the most willing to share the rises with customers. A key factor for this is the popularity of the Livret A, a 200-year-old savings account designed to help restore France’s public finances after Napoleon Bonaparte’s wars.

Livret A deposit accounts are linked to inflation and set by the government. At 3 per cent, rates on the account are at their highest level in 14 years. 

Luxembourg banks have one of the highest levels of deposit beta across the eurozone at 36 per cent, but as much as a quarter of that is due to customers switching from current accounts to fixed-term accounts, which offer higher rates in return for locking up their money for a year or more.

The rate of migration to higher earning accounts is much lower in countries such as the UK, Spain, Italy and Ireland as savers facing rising costs prioritise instant access to savings.

Countries hit hardest by the eurozone crisis more than a decade ago and where the sector was forced to consolidate — such as Ireland, Spain, Greece and Italy — have also proved much less willing to pass on policy rates to customers.

“If you have fewer banks in the system, they control the market and they can more effectively control how much is passed on to consumers.” said Charnay of S&P.

Spanish banks have one of the lowest pass-through rates in Europe, despite the Socialist-led coalition government introducing a controversial windfall tax this year aimed at hitting banks that benefited most from a rise in net interest income.

“I’m not sure how effective the windfall tax was in pushing banks to raise deposit rates — it doesn’t address the core factor, which is the level of competition in the market,” added Charnay.

Citi estimates that deposit betas across the eurozone will rise from an average of 25-30 per cent this year to 30-40 per cent next year, while US banks will rise to 45-55 per cent by the end of this year.

“Ultimately it comes down to how much political pressure banks are willing to absorb compared to the profits they are finally making after years of low or negative rates,” said a European bank executive.