To no-one's surprise, the Bank of England’s rate-setting committee kept the base rate at 0.5 per cent yesterday. While anyone with a mortgage will have breathed a sigh of relief, savers will take the announcement as further confirmation that they’re unlikely to earn a decent return any time soon.
But is the low base rate really the reason that savers are getting such a bad deal? A bit of digging suggests otherwise. In April 2011, savers could earn 2.7 per cent on a one-year fixed rate Isa. Four years later, despite the base rate remaining absolutely constant, the same product pays just 1.5 per cent.
The picture is equally murky when you look at personal loans: despite the base rate falling from 5.75 per cent in July 2007 to 0.5 per cent in March 2009, costs for those borrowing £5,000 actually increased over the same period, and five years later they’re roughly where they were before the base rate fell.
You might expect a discernible link between movements in the base rate and the rates passed on to you and me – but the connection is opaque. The reality is that the base rate sets the scene, but thereafter the banks decide the rates – they decide how much they want to pay you for your money. Take it or leave it.
This leads to an interesting thought experiment: what would happen if you cut out the bank, and allowed investors and borrowers to mutually agree the rate? In fact, peer-to-peer platforms such as RateSetter have been doing this for years – our one-year rate has averaged 3.7 per cent over the past three years, although it’s important to note that our product is not Financial Services Compensation Scheme-protected and carries risk. It’s been as low as 2.6 per cent and as high as 5.4 per cent, fluctuating according to the supply and demand of money: a real-time rate based on millions of real-world transactions.
Because our rate is set this way, representing the collective view of hundreds of thousands of customers, we refer to it as the People’s Rate. Here’s the interesting bit – it suggests that a fair value rate for one-year money is much higher than the 1.5 per cent banks are paying (bear in mind that some banks pay even less than this).
So what’s happening? Is the base rate a red herring? Not quite. The rate set by the Bank of England is clearly important, but it’s not the only cause of low savings rates. Savers pinning their hopes on an increase in the base rate might be disappointed – banks will pay a better return when they want to (i.e. when they need the money, perhaps when Funding for Lending runs dry) or when they’re forced to (when their competitors up their rates).
A more succinct way of saying this is that banks will always pay as little as they can to savers, regardless of where the base rate lies.
For centuries, people have had no alternative but to accept rates set by bank committees. Our experience – allowing investors and borrowers to set rates themselves – shows that this isn’t the only way to do things.
Rhydian Lewis is chief executive at RateSetter.