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Are You Ready for a Cashless Society?Early Withdrawal Bonus? New CDs Will Give Savers More Options
How would you design a better CD? You can't design it to be better for just the depositor. It has to be a win-win for both the depositor and the bank. That's what Neil Stanley has been working on. In his article at Banking Strategies, From Commoditized to Customized Deposits, he describes ways CDs can be improved so that banks can attract and retain depositors. He warns banks that CDs are declining in popularity, and this decline isn't just due to the low interest rate environment. Offering more customized CDs will allow banks to attract more deposits without offering the highest interest rates.
One interesting feature Stanley proposes is an early withdrawal that would be similar to the gain/loss an investor would experience when selling a bond or a brokered CD:
* Have the option to withdraw early from the time deposit with all principal and interest and a “bond-like” gain when interest rates have dropped
This feature has already been implemented in a direct CD at one Iowa bank. Treynor State Bank offers a CD that is called CDtwo. Here's how the bank describes the early withdrawal penalty/bonus:
After the first 7 days, the penalty/bonus is determined by the Replacement Fee. The Replacement Fee is an estimate of the interest cost to us if we were to replace a CD that is withdrawn early with another deposit having a term that is comparable to the remaining term of the original CD. 18 month - 60 month terms available. If interest rates have risen, then the cost of the new deposit will be higher. If interest rates have fallen, then the cost of the new deposit will be lower.
One thing nice about this feature is that the bank is upfront about the early withdrawal. There's no assumption that the depositor will hold deposits until maturity. So depositors shouldn't have to worry about a bank refusing an early withdrawal request or surprising depositors by changing the costs of early withdrawal on existing CDs. Two credit unions have already increased early withdrawal penalties on existing CDs. The worry is that we may see more of these actions when interest rates go up.
Another nice thing about this feature is that it could provide a bonus for an early withdrawal when rates have fallen. This is similar to what some banks have done in the last few years by temporarily waiving early withdrawal penalties on existing CDs. In these cases, the banks are hoping to close the "expensive" CDs. For depositors in this case, the only reason you would want an early closure would be if you have an immediate need for the money.
The downside with this feature that I see is that the replacement fee is more complicated than the typical early withdrawal penalty. The typical EWP is often just 6 months of interest on the amount withdrawn. That's easy to understand, and it's easy to calculate the consequences of early withdrawals.
What do you think of this early withdrawal feature? And what CD features would you like to see from banks and credit unions?
Edit 4/8/13: Removed "Refinance conventional CDs" bullet.
When you get 1 or 2% interest on your money, you already lost part of you principle due to higher inflation rate and when you include penalties, you have lost twice.
I spent my entire career in the real estate finance business, and I was warning people about a real estate bubble 3 years before it happened. I knew that the correlation between housing payments and median income was not making any sense and that the double digit price increases could not continue. Very few people took me seriously and there were times I seriously doubted myself and everything i had learned about the industry. Eventually, I was vindicated but it took a while. I think the same situation exists today. Someday we will pay the piper for our profligacy.
if inflation goes up even more, the reciprocity of higher interest rate will always lag the purchasing power of your savings. So, you loose twice again.
Bernanke can manipulate the value of the dollar to his likings and our savings will be destroyed with higher inflation. That is what he is doing now, printing money and keeps low interest rates with hidden inflation.
Dollar looses the purchasing power without true compensation for our savings. They will continue for long term or until the dollar will colapse of it worthless denomination.
You asked in an earlier comment about the specifics of the 8.96% yield. That CD had a 2.40% rate, but was redeemed with a gain that produced the 8.96% yield when the gain was added to the principal and interest at redemption.
I urge you to consider that the CDtwo is structured like the bonds that the banks buy for themselves and the redemption option is solely the depositors. The bank retains no special value for themselves with this. It is really designed to pass along the full risk and value of long-term investing. With a conventional CD, banks don't pass along the full value including price appreciation.
Neil, with all due respect, this is quite different than what happens when you sell your bond on the secondary market through a broker. In that situation your bond is priced according to market rates as determined by what buyers and sellers are willing to transact for that bond on the day you decide to sell. In this situation, you are at the mercy of the bank who will ESTIMATE their interest cost to replace your CD. Banks can pay rates that are higher or lower than the market rate, so to have rely upon their ESTIMATE of their interest cost or whatever they decide to pay for their CDs on any given day. In my view, this gives them too much control of the process in determining the value of your CD. In effect, they decide what the market is.
I cannot overstate my appreciation for your concern. We know that the “devil is often in the details”. But, keep in mind that the bank offering to redeem the certificate will disclose the replacement rate to the depositor. As you suggest, the bank that overstates their replacement cost has just made an over-the-market offer to the depositor who could respond this way…”Given that your replacement cost today on my CD is X%, I find that attractive. Instead of redeeming my existing CDtwo, I will open another CD for the remaining term of this one at that rate!” I think you can see the fairness inherent in the system where the bank has to see themselves as both issuer and redeemer at the rates they quote. Therein lies your buyers and sellers perspective.
I don't find this deal attractive because If I am going to assume the risk of not knowing what my CD is worth prior to maturity, then i would need a better rate to compensate for the lack of certainty. If anything the risk of interest rates going up is far greater than they are of going down. The investor is assuming far greater risk than the bank. 1.10% is way too low. Currently, you can find 5 year CDs at around 2% with some other credit unions. If Treynor bank wants my business, they would have to increase their rates far more than what they are offering today.
Every depositor should always consider both price and structure. I don't dismiss anyone's assessment today that the current yields are low and that rates might rise. My goal has been to enhance the structures available to depositors regardless of price. With CDtwo we have developed the ability for bank customers to buy the same kind of structure the banks themselves buy. This market value time deposit structure will be available not just when rates are low. Keep in mind that one depositor netted over 8% yield on a CD with a 2.4% interest rate. Over my professional career 2.4% is a low rate, but I tend to feel pretty favorable about 8% yields. Therefore, I hope you don't categorically dismiss the structure that can deliver this performance.
In addition to the creation of CDtwo which benefits the depositor in steady and falling rates, we have created the most efficient way to refinance CDs in a rising rate environment. So, I appreciate that the depositor's rate expectations should play a role in these decisions. What I have been striving to note here is that the conventional CD is decidedly inferior in a steady or falling rate environment when the penalties used are not based on an economic foundation. Best regards, Neil
BTW, how much do you care about the rating if your account is 100% FDIC-insured?
The rates are posted and the actual cash flow yields from early redemption depend on future rates. The yield we are discussing of over 5% was created by an early redemption by the owner on a CD with a 2.20% APY. What would you like to see?
What we are discussing here is a fixed-rate contract which paid a 2.20% APY since 12/1/2016 and would continue to maturity. Any day the depositor can check the redemption value and decide if they want to keep the contract or redeem. The options are entirely the depositors. I am touting commitments by the financial institutions which provide fairly priced options to the depositor. Seems like something the DA audience would embrace when the details are made clear.
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" Seems like something the DA audience would embrace when the details are made clear."
Really? 2 months of comments, between 3 people ?