CD Rates Face New Threats from Well-Intentioned Banking Proposals
February 21, 2010
| MoneyRates.com Senior Financial Analyst, CFA
When people look back at the financial crisis, it's important to remember that the effects of that crisis are not fully behind us yet. In fact, they could continue to affect bank rates for a long time to come. One of these matters with long-term consequences is the funding of the the Federal Deposit Insurance Corporation (FDIC). For a while now, there has been a tug-of-war between cutting further into bank rates and shoring up the reservoir of funding that the FDIC has ready to protect depositors from bank failures.
Naturally, both bank rates and deposit security are important issues to anybody with funds in savings accounts, money market accounts, and CDs. As much as deposit security might be the top priority, though, with 1-year CD rates already below 1%, you can see how depositors might also be pretty sensitive to just about anything that threatens to further erode bank rates.
President's Proposal for the FDIC Insurance Fund
Historically, the FDIC has maintained insurance reserves in a range between 1.15% to 1.50% of deposits. That has worked just fine under normal circumstances. But when there are an unusual number of bank failures--as was the case in 2008 and 2009--that reserve can get used up.
Already, the FDIC has had to accelerate the insurance levy it imposes on banks in an attempt to rebuild its reserves. President Barack Obama has proposed raising the insurance fund past the 1.50% mark, which had been the previous ceiling. Such a reserve would require even greater efforts to reach.
Impact on Bank Rates and Depositors: Good News, Bad News
For depositors, this raised reserve proposal is a mixed bag of good and bad news. Naturally, anything that enhances deposit security is good news. However, the bad news is that increasing the insurance levy is likely to further cut into bank rates.
In the wake of the banking crisis, a series of business restrictions, fees, and taxes have been either imposed or proposed. Already, many banking industry observers are concerned that banks will just pass the cost of these measures on to their customers. Since FDIC insurance premiums are levied as a percentage of deposits, they seem especially likely to come out of depositors' pockets in the form of lower bank rates.
Camden Fine, the head of the Independent Community Bankers of America, pointed out in American Banker that to meet the low end of the original target reserve level would already require the FDIC to levy as much as 17 cents for every $100 of deposits over eight years. If that entire amount were passed through to customers, a depositor would effectively be paying 0.17% (in the form of reduced rates) for FDIC deposit insurance.
Under normal circumstances, with 1-year CD rates at roughly 4% or 5%, any increase on that 0.17% might go relatively unnoticed. However, at the beginning of February 2010, the average 1-year CD rate reported by the FDIC was only 0.82%. A 0.17% levy on deposits represents about one-fifth of the interest yield the customer is getting. Further raising that levy would mean depositors would sacrifice an even greater share of their meager interest earnings.
An Alternative Approach
If the goal is to enhance depositor security, there are alternatives, such as raising the reserve requirements for banks, or restricting the risks that banks can take on through their investment activities--risks that endanger the safety of deposits. It could be argued that these approaches would also suppress the potential earnings banks could pass on to their depositors, but recent history has shown that it was only the risk, and not the return, from higher-risk activities that got passed on to bank customers.
