Why Banks Need 'Sleepy' Customers

Many people put their bank accounts on autopilot, rarely changing or even looking for better terms. It turns out they’re also helping to stabilize the US banking system.

Some 94% of depositors leave their funds idle in the same bank every year, even when moving their money could get them a better interest rate. This inertia, referred to as “sleepiness,” undergirds the $18 trillion US deposit market and boosts banks’ profits and franchise value—the overall valuation of the bank, including the long-term value of its customer relationships—says research by Harvard Business School Professors Mark L. Egan and Adi Sunderam.

JP Morgan Chase, Bank of America, and Wells Fargo—the three largest US banks—enjoy reliable fee revenue from sleepy customers, saving them the cost of attracting new customers. These accounts have also helped these banks weather economic challenges, like when interest rate hikes chill loan demand and stir competition.

“About 60% of bank value comes from the fact that just most of their depositors are not paying attention,” Egan says. “Because this contributes to bank profitability, it actually makes them more stable.”

Egan and Sunderam, the Willard Prescott Smith Professor of Corporate Finance, share their findings in the September working paper “Dynamic Competition for Sleepy Deposits.” They coauthored the research with University of Chicago Professor Ali Hortaçsu, Harvard University doctoral student Nathan Kaplan, and Georgia State University Professor Vincent Yao.

Why bank customers stay put

Between 5% to 15% of account holders search for higher interest rates every year. Banks are more likely to shutter accounts after inactivity, death, or relocation than because a customer sought better terms elsewhere. The authors also found that:

• Older depositors are less likely to switch banks than younger account holders.

• “Time deposit” holders, whose products have a maturity date that forces them to decide whether to stay, switch more often than checking and savings account holders.

• Accounts with larger balances and those held by businesses also have higher turnover than individual accounts.

And despite their convenience, online account holders tend to be sleepier than people who open accounts at branches. Egan says that it’s easier for these customers to keep their accounts when they move, and many people are loath to set up automatic bill payments again at a new bank.

How sleepy deposits support banks

To trace the impact of sleepy deposits, the authors analyzed more than 25 million accounts at 164 banks and credit unions from 2002 to 2023. They were culled from 58 million anonymized accounts tracked by the payments firm Fiserv.

Researchers tapped market share and branch data from the Federal Deposit Insurance Corp., and deposit rate information from RateWatch. Census data helped the team understand depositor demographics, while credit default swaps served as a gauge of bank risk.

The benefits of sleepiness to banks were clear. Without sleepy deposits, the industry might have:

Higher default rates for large banks

Without significant changes to adapt their business models, the default risk for major banks could be 10 percentage points higher in normal times and 20 points higher in situations that erode profits, like when the Federal Reserve hiked rates in 2022 and 2023 to fight inflation.

Higher customer recruiting costs

Attracting new customers is costly: banks lose 15 cents for each deposit dollar acquired. And it takes more than a year to close that gap and start profiting once the new depositor turns sleepy, the authors find.

A decline in small- and medium-sized banks

Sleepiness protects small and medium-sized banks more than big, more stable institutions. Banks with higher operating costs or low-quality products would lose up to 80% of their value if depositors were to “wake up” and look for better rates, the authors estimate.

“What helps keep smaller and midsize banks in business is the fact that most of their depositors are asleep,” Egan explains. “If you were to implement something like floating-rate deposits, we would see a shift away from these smaller, mid-sized banks towards larger banks.”

Fewer options to weather economic shifts

Depending on rate conditions, banks must balance how much to invest in keeping active customers while harvesting from sleepy customers by paying them lower rates.

“Sometimes banks are going to price really aggressively and give you good deposit rates as a consumer,” says Egan. “They tend to do that when aggregate rates are low. Then there are going to be other times when they harvest.”

Benefits of sleepiness

The research reveals just how vital invest-versus-harvest decisions are to bank health, a lever that would be more difficult to balance without sleepy customers willing to accept lackluster deposit rates.

“Any sort of thing that would get rid of sleepiness, like floating rate-deposits, would hurt that deposit franchise value, and make things potentially more unstable when there’s any volatility on
the asset side,” Egan says.

UK regulators have advocated that banks pass on more of their rate gains to depositors. In the US, such a policy would benefit consumers modestly, while chipping away at financial stability, especially when the Fed raises interest rates and curbs the money supply to slow inflation, the researchers found.

“Especially as rates rise, it's a particularly good time to try to shop around,” Egan says.

Illustration credit: Ariana Cohen-Halberstam with photo from Adobe Stock/BTG.