Why do term deposit rates keep dropping?

If you have been holding term deposits, you may have noticed that the interest rates have been falling.  Some may be a little confused why the interest rates were dropping well before the RBA made the change, and are questioning whether they will continue to fall?

Part of the answer comes back to the source of funds.  In the past, local banks had been required to obtain deposits from a retail investor through their bank branch network.  This is via a more traditional avenue, whereby a person goes into a bank and deposits funds into a term deposit.  The banks have found over the past few years that this can be a particularly expensive source of funds.

Needless to say, since then, the need to tap this retail market has reduced.  Quiet simply, the banks just don’t really need those term deposits as much as they did a couple of years ago.  The main reasons is they can access the funds cheaper via the overseas market.

An example of this is in the Euro zone, where we have recently seen a french utility bond issue half a billion dollars with a 0%  interest rate. Whilst they will need to pay the funds back, it is interest free rather than totally free.

But it is not just European companies which are taping into this market, as we are also seeing large international companies abroad following suit. Berkshire Hathaway is also planning to issue a 3 billion euro bond again at a 0% interest rate – not that they need the cash, but if they are handing it out at 0% interest rate, I guess you can always count on Warren Buffett to put his hand out!

Now you may scratch your head a little and go “why would somebody give their money away at a 0% interest rate?”  It would be like today going into a bank and asking them to lock away your money for 0% interest for 12 months.  However in some countries this is exactly what is happening with interest rates being so low.

The reality today however, is like the examples above, the local banks here in Australia have also been tapping this market too-  thus allowing them access to cheaper lines of cash and allowing them to make larger margins and consequently doing away with the notion of the retail investor going into their branch depositing their funds.

There are several other factors why the interest rates have been dropping too-  but that is for another day.

So if you don’t know what to do with the term deposit, it is always important to seek professional guidance, and we would recommend AJ Financial Planning.