In both cases, the study was limited to institutions for which interest-rate data was consistently available from RateWatch, a service that tracks bank-branch interest rates and is widely used in academic research. On the basis of these data, the researchers looked at what they determined was a representative group of retail banking products that included savings and money market accounts, certificates of deposit, and individual retirement accounts. As expected, considering that online banks pay higher rates, inflows into interest-bearing deposits were larger for online banks than for traditional ones. There was no difference in terms of inflows among deposits that paid no interest.
The key difference between the two groups of similarly sized banks they assembled was technology, the researchers find. Sitting in the comfort of their living rooms, online customers can compare the rates offered by rival banks as well as by mutual funds and other alternatives. Then, with a few mouse clicks, they can quickly transfer money between institutions.
The frictionless ease with which customers can take advantage of outside investment opportunities forces online banks to offer competitive interest rates. Deposits at brick-and-mortar banks, by contrast, tend to be sticky, meaning the incumbents face less pressure to raise rates in order to retain assets.
The researchers considered whether variations among customers, rather than technology, might explain the banks’ different responses to increases in benchmark interest rates. For example, it might be that online banks tend to offer higher deposit rates because their users are younger, more educated, and more inclined to spend additional time comparison shopping among institutions.
To adjust for this possibility, the researchers compared online banks with branches of traditional rivals located in zip codes with similar demographics. The results were still remarkably similar across markets with different types of clients and levels of competitiveness, which suggests they were indeed driven by the technological differences rather than factors such as the type of customers the banks attract.
The migration of deposits online accelerated further after the Federal Reserve began hiking interest rates in spring 2022. Institutions that the researchers identified as purely online held about 5 percent of total system deposits as of March 2023.
Observers have long known that when monetary officials alter interest rates, the effects become muted as the rate changes flow through banks. By lowering retail customers’ search costs, online banks are increasing the speed at which those changes pass through the banking system. As their market share grows, they could radically affect the way monetary policy is transmitted, requiring regulators to update their models and guidance, the researchers write.