Bank Deposit Rate Clustering: Theory and Empirical Evidence

Abstract

The market prices of stocks and other assets tend to cluster on round fractions. A similar clustering is found in the interest rates paid on retail bank deposits. However, the theoretical rationales given for asset-price clustering are incompatible with the clustering of retail deposit rates. This paper proposes a theory based on depositors limited recall. It shows that when banks exploit this phenomenon, deposit rates will tend to be set at round fractions and will be relatively sticky at these levels. The implications of this theoretical model are tested using money market deposit account and retail certificate of deposit interest-rate data from a sample of more than 500 banks.