CD Rates Hang in the Balance of Bank Reform Debate
March 16, 2010
Since the credit crisis, there's been talk of reforming the banking sector and increasing government oversight of financial institutions in the hopes of avoiding future meltdowns.
In early March 2010, details were released on banking reform legislation to be proposed by US Senate Banking Committee Chairman Christopher Dodd. Precisely which provisions will make the final bill is unclear, though many of the key reforms have been under discussion for some time. How will the likely provisions in the proposed legislation affect bank depositors?
In particular, anyone with funds in deposit accounts cares about two things: higher bank rates and deposit security. Depositors are fed up with rock-bottom CD rates and other bank rates and want to know what in the bill might foster higher bank rates. Security of bank deposits is something US bank customers generally take for granted, but with the 2008 financial crisis, it can no longer be viewed as a given.
Based on those two interests of bank customers--higher bank rates and deposit security--how is banking reform shaping up?
The Latest Proposal
Senator Dodd's proposal rearranges the banking oversight responsibilities that are now spread among various areas of the federal government. Notably, it would create an independent financial regulatory division under the Federal Reserve to protect consumer interests. This new Fed division would have lead responsibility for supervising major banks and also non-bank financial institutions, including the management of systemic risk--the build-up of risky financial positions that could have damaging repercussions in the economy beyond an individual bank or two.
Significantly, reforms will likely include some form of the much-discussed "Volcker rule," which would restrict banks from riskier activities such as proprietary trading. If passed, such restrictions would prevent a bank from owning or investing in hedge funds, for instance.
Financial Reform and CD Rates
So what does all this mean for your CD rates? Well, representatives of the banking industry might argue that restrictions on the risk-taking activities of banks could be bad for depositors' CD rates.
The theory is this: the less restricted banks are, the more constructively they can invest their deposits; the higher the returns they can earn on those investments, the more valuable the underlying deposits become to the banks; the more valuable those deposits are, the more bank rates will rise to attract deposits.
The problem with that argument is that risk-taking doesn't always pan out. If the investment activities of the banks backfire, there is less rather than more money in the system to pay out in the form of higher CD rates and other bank rates. Indeed, the record low bank rates seen over the past year can be directly traced to the risk-taking activities that precipitated the financial crisis.
Although a prohibition against proprietary trading and speculative investment by banks could mean that depositors miss out on higher yields driven by outsize returns in a recovery, it could be that moderate, stable bank rates are better for depositors in the long run.
Reform and Deposit Security
If the impact of the proposed legislation is a mixed bag when it comes to bank rates, it may be slightly less ambiguous in enhancing deposit security. The legislation gives the Federal Deposit Insurance Corporation (FDIC) purview over some of the institutions that were previously under the Fed. It also creates a council composed of eight members from various regulatory agency to monitor systemic risk, with a hand in unwinding institutions about to fail before the effects spread economy-wide.
Of course, whether one regulator or another--or a group of them--will be more effective in the face of a new crisis remains to be seen.
