What it means
A deposit rate is a price, and like any price it moves with supply and demand plus the central bank's policy rate. When policy rates rise, banks usually pass some of the increase to savers, but rarely all of it and rarely quickly.
The difference between what a bank earns on its assets and pays on its deposits is called the net interest margin, and it explains why the rate on an instant-access account is often disappointing. Rates vary by product because banks are paying for certainty as well as for the money itself.
An instant-access account pays least because you can withdraw at any moment; a notice account pays more because you must give warning; a fixed-term deposit pays most because the bank knows exactly how long it has the funds. The longer you tie the money up, the more you are compensated, and the less flexible your treasury position becomes.
For a business this is a live decision rather than a background detail. Most companies hold a working balance that must stay instantly available, a buffer that could sit in notice, and a strategic reserve that could be fixed for six or twelve months.
Splitting the balance across those three buckets, sometimes called laddering, usually earns materially more than leaving everything in one current account. Two details are worth checking before comparing headline rates.
The first is the day count basis, since some quotes use 365 days a year and some use 360, which changes the interest on short deposits. The second is compounding frequency, because a rate paid monthly and reinvested produces slightly more than the same rate paid annually.
Finally, deposit rates carry risk that is easy to forget. Chasing the highest advertised rate can mean placing money with a smaller institution, so treasurers check deposit protection limits and spread balances rather than concentrating them.
A slightly lower rate at a stronger bank is often the better trade.
In practice
Real-world examples.
Example
A software startup closes a $6,000,000 funding round and leaves it all in a current account paying 0.5%, earning $30,000 a year. Moving $4,000,000 into three-month term deposits at 4.0% earns $160,000, while the remaining $2,000,000 still earns $10,000, for a total of $170,000. That is an extra $140,000 with no change to the operating plan.
Example
A seasonal retailer collects heavy December takings and knows it will not need $1,200,000 until late February. Placing it on deposit at 3.0% for 60 days on a 360-day basis earns $1,200,000 x 0.03 x 60 / 360 = $6,000, which covers a large part of the January payroll run cost.
Example
A small charity holds an $800,000 reserve that funds part of its annual budget from interest. When rates fall from 4.5% to 2.5%, income drops from $36,000 to $20,000, a $16,000 hole the trustees must fill through fundraising or cost reduction.
Formula
Calculation
Interest earned = Principal x Annual deposit rate x (Days held / Day count basis)
Effective annual rate = (1 + Annual rate / Compounding periods) ^ Compounding periods - 1
A distributor places $250,000 into a 90-day notice account paying 3.6% a year, quoted on a 360-day basis. Interest for a full year would be $250,000 x 0.036 = $9,000. For 90 days, interest = $9,000 x 90 / 360 = $2,250.
Left in the company's current account paying 1.2%, the same money would have earned $250,000 x 0.012 x 90 / 360 = $750. The improvement is $2,250 - $750 = $1,500 per quarter, or roughly $6,000 a year if the balance and the rates hold. If the 3.6% rate were credited monthly and reinvested, the effective annual rate would be (1 + 0.036 / 12) ^ 12 - 1 = 3.66%, slightly better than the headline figure.Case study
Seen in the real world.
Harbour Lane Bakeries is an illustrative and clearly fictional regional bakery used here to show deposit laddering in practice. It carried an average balance of $1,500,000 in a single instant-access account paying 1.5%, producing $22,500 of interest a year. The owner assumed this was simply what banks paid and never revisited it.
A new finance manager analysed twelve months of daily balances and found the business never dipped below $900,000. She split the money three ways: $500,000 left instantly available at 1.5% earning $7,500, $500,000 into a 90-day notice account at 3.4% earning $17,000, and $500,000 into a twelve-month term deposit at 4.2% earning $21,000. Total interest rose to $45,500.
The extra $23,000 a year was roughly the cost of a part-time delivery driver, earned with no additional risk beyond a modest loss of flexibility on two thirds of the balance. The lesson in this fictional case is that deposit rates only reward businesses that ask for the better rate and structure their cash to qualify for it.
Watch out
Common mistakes.
- Comparing headline deposit rates without checking whether they are quoted on a 365-day or 360-day basis, which quietly changes the interest earned on short placements.
- Leaving the entire cash balance in one instant-access account because "we might need it", when daily balance history shows a large permanent core that never moves.
- Chasing the top advertised rate at an unfamiliar institution without checking deposit protection limits or spreading the balance across banks.
Questions
People also ask.
Does a higher deposit rate always mean more income?
Not if it comes with a term you cannot honour, because early withdrawal penalties can wipe out the extra interest and more.
How does the deposit rate relate to the central bank rate?
It generally follows it, but banks pass on increases partially and slowly while passing on cuts quickly and fully.
Should a business worry about inflation when comparing rates?
Yes, because the real return is roughly the deposit rate minus inflation, and a 2% rate against 4% inflation still means losing purchasing power.
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