2.1.3 Why savings rates differ

In Table 2.2 that you just looked at, the five-year Fixed Rate Bond and the Notice Account both have higher net rates than the Instant Access account. The amount saved also influences the rates offered for both Instant Access and Notice accounts: the higher the savings deposited, the higher the rate.

The Internet Savings account can offer higher rates due to the lower costs of managing the account. Despite this, some people will still choose the most basic Instant Access account, mainly because it provides plenty of flexibility, with instant access using a cash card, so that money can be accessed night or day. The downside is the lower interest rate on offers.

The ISA (Individual Savings Account) is not subject to tax so all savers get the full (or gross) amount of interest. To encourage saving, the annual limit for investments in ISAs is £20,000 per person in 2018/19.

In the March 2016 budget statement it was announced that a new ‘Lifetime ISA’ would be available from April 2017 for those aged under 40 years. These new ISAs will allow tax-free savings of up to £4,000 per annum with the government topping up balances by £1 for every £4 saved. Lifetime ISAs, which can be built up until the age of 50 years, are intended to help people save for property purchase or to help provide income in retirement. To support this development the overall ISA limit (for both ordinary and lifetime ISAs combined) was raised to £20,000 from the 2017/18 tax year.

A new savings scheme for those on low incomes was also unveiled in March 2016 with those on in-work benefits who save £50 per month for up to 4 years getting a 50% (up to a maximum of £1200) top up from the government.

While this and the previous section focus on differentials between types of savings accounts, the general level of rates will be related to the Bank of England’s Bank Rate. If Bank Rate rises then, perhaps with a short delay, savings rates will normally rise too. A falling Bank Rate will normally result in falling savings rates.

The difference, or ‘margin’, between Bank Rate and the general level of savings rates is prone to variation though. The circumstances under which the margin is low are when banks and other financial institutions are not keenly seeking funds from savers. This can be where:

• The amount of new lending being undertaken by banks and other lenders is low – so creating only a limited need for funds to support this lending.
• Alternative sources of cheaper funding are available from the wholesale financial markets (other banks and institutions), with the result that savings from personal investors are not needed. In Week 1 you saw how the Funding-for-Lending Scheme provided such cheap funds to lending institutions from 2012 with the consequent adverse effect on the general level of savings rates for personal investors.

By contrast the margin over Bank Rate for the general level of savings rates will be high where:

• The amount of new lending being undertaken by lending institutions is high.
• There are limited alternative sources of funding, at reasonable rates of interest, to personal investors’ savings. This scenario applied during and immediately after the 2007/08 financial crisis when banks and other lenders had difficulties accessing reasonably priced funds from the wholesale markets.