Bank Competition and Inattentive Depositors

Banks compete to attract depositors, who care about the interest rates they earn on their deposits, the fees they are charged, and the services they receive. However, once they have chosen a bank in which to deposit their money, depositors rarely switch, even when, as is regularly the case, superior alternative options become available. This “sleepy” behavior by depositors mutes competition between banks and can cause depositors to leave large amounts of money on the table.

In Dynamic Competition for Sleepy Deposits (NBER Working Paper 34267), Mark L. Egan, Ali Hortaçsu, Nathan A. Kaplan, Adi Sunderam, and Vincent Yao combine anonymized consumer financial data with a model of interbank competition to explore the implications of sleepy depositor behavior.

Most bank depositors rarely switch banks, a “sleepy” behavior that allows banks to offer lower interest rates and to charge higher markups.

The researchers begin by demonstrating that sleepy behavior is widespread. Fewer than 15 percent of the checking or savings accounts active in a given year were opened that year, and the typical account is used for about 8 years after being opened. Account turnover is particularly low among older depositors, while it is higher for business accounts and high-balance accounts, perhaps indicating the greater sophistication or lower search or switching costs of the latter type of depositor.

When depositors do switch banks, it is usually not because they have sought out a better deal. Instead, it is typically driven by major changes in life circumstances such as moves or deaths. Only 17 percent of account closures involve a depositor who reports that they are switching to another bank because it offered them better terms.

The researchers also estimate a dynamic model of competition between banks, postulating that depositors alternate randomly between periods of “sleeping,” when they do not consider changing banks, and periods of “waking,” when they reassess their depositing choices. 

Banks face a trade-off between setting high interest rates to attract awake depositors and setting low interest rates to extract profits from their current sleeping depositors. The effect of a decline in depositor wakefulness is ambiguous. On the one hand, when fewer depositors are awake and poachable each period, the incentive to raise rates is weaker. On the other hand, fewer waking periods mean that a poached depositor is expected to stay with the bank longer, heightening the incentive to raise rates to attract new depositors.

The researchers’ estimates suggest that the average markup charged by banks, the difference between their cost and the effective “price” that they charge to depositors, is 68 basis points per year.  The researchers estimate that in the absence of sleepy depositors, the markup would fall by half to 32 basis points.

Increases in market concentration do not seem to change markups very much. About 58 percent of the average bank’s deposit-related profit stream can be attributed to depositor sleepiness and correspondingly higher markups, but the researchers find substantial heterogeneity across banks in the relative importance of depositor sleepiness. Sleepiness particularly benefits banks with high costs as well as banks with low-quality deposit services.

                                                                                                                        - Shakked Noy