Did the rate on your savings account go down? Here's why

You’ve likely noticed the interest rate gains landing in your savings account has recently dropped. In some cases, by quite a bit.

Among the numerous, disorienting financial impacts of the COVID-19 pandemic, the Bank of Canada’s policy interest rate reduction was arguably one of the most important. In late February, the Bank of Canada interest rate sat at 1.75%. Roughly one month later, it was 0.25%.

This single rate affects banks, borrowers, and savers alike.

First, the basics: Bank of Canada policy rate vs. prime rate

The Bank of Canada’s policy rate (also known as the overnight rate) is used when banks lend or borrow from each other in the interbank market. As noted above, this figure sits at 0.25%. But when banks lend to everyday Canadians (like you and I), they do so based on what’s known as the prime rate.

Prime rates are closely linked to the Bank of Canada’s policy rate. When the policy rate goes down, the prime rate follows suit. Likewise, if there is a Bank of Canada interest rate hike, the prime rate rises accordingly. 

Loans to most Canadians are offered at prime plus an additional percentage. For example, with the current prime rate at 2.45%, a prime plus 1% rate would total 3.45%.

The central bank’s interest drops in March were designed to stimulate the economy by making it cheaper to borrow money, alleviating some of the economic impacts of pandemic-related closures and job losses. As intended, Canada’s major banks followed the move, dropping their own prime rates.

By changing the policy rate, the central bank’s policy trickled down to everyday customers – making borrowing easier and cheaper so Canadians can stay afloat during the financial aftershocks of COVID-19.

How rate changes impact borrowers vs. savers

For borrowers with variable rates – i.e. not locked in, pre-pandemic – recent rate drops means mortgages, lines of credit and other loans will now collect less interest and it’s cheaper to borrow. New borrowers should also benefit from rock-bottom rates; only those with fixed rates will see no change.

For many savers, however, interest earned also dwindles due to the drop in prime rates.

The central bank’s rate typically ripples through Canadian banks’ policies, including how they reward their customers for keeping cash with them.

Since banks are now earning less revenue from the interest on mortgages and other loans they lend out to Canadians, in turn, they pay out less interest on savings accounts. It’s a simple matter of money in versus money out.

While many borrowers benefit from rate drops, savers see fewer returns – two sides of the same sword.

Why savings accounts are still worth it

While savings accounts rates may have dropped, that shouldn’t deter you from having one.

Savings accounts offer a safe way to store and easily access your money at any time while also earning some guaranteed (albeit modest) returns to combat inflation – an area where chequing accounts fall short.

Whether it’s to hold an emergency fund or keep some liquid cash within close reach, savings accounts are still worth it. And if the rate for your particular savings account has dropped, don’t settle but shop around and switch over to a new account with a better rate.

Rate leaders for savings accounts during the pandemic

Some of the best high-interest savings accounts on the Canadian market come from smaller players: so-called digital banks.

These institutions don’t have the brick-and-mortar branch locations of Canada’s big six banks, a digital business model that saves money on operations and overhead. As a result, they can enter the market competitively with some of the best savings account rates – well above what some of the big banks offer.

Also read:

Overnight Lending Rate in Canada