Certificate of Deposit Investors: U.S. Banks Want You
July 07, 2009
Looking at market rates for certificates of deposit, it is clear that there are premium rates out there for CDs of any length for those bank customers who are smart enough to shop around. This premium appears to expand as you move out to longer-term CDs--but why is that? Clearly, certain banks recognize that customers who are willing to commit their money to a CD for multiple years are especially valuable in this environment.
There is a good reason why banks feel this way--in fact, three good reasons. For you, understanding the logic behind these bank CD rates may help you take advantage of those offers with confidence.
Recent CD Rates
As of late June, 6-month CD rates averaged 1.47%, and 2-year CD rates averaged 2.09%. There is nothing unusual about that--longer-term investments generally yield more. On top of the normal premium though, comparing the best CD rates in each category revealed especially good offers in the longer-term category.
In each case, the "best CD rates" were measured as the top five rates in the category among those that were generally available in all parts of the country. The average of these top five was used to measure the premium that the best CD rates offered over the category average. For 6-month CD rates, that premium was 0.47%. For 2-year CD rates, the premium jumped to 0.68%.
Reasons Why Banks Want Longer-Term Deposits
Let's look at why some banks are offering particularly attractive rewards for longer-term CDs, beyond the average premium for those CDs. There are actually 3-reasons:
- Your confidence is worth something. Risk may not seem like much of a factor in FDIC-insured accounts, but coming out of a banking crisis, banks recognize that some customers may be hesitant to make long-term commitments with their money. Those banks who are assertively seeking to attract depositors and build their repuations may be willing to offer a little extra to those customers who are willing to show that kind of confidence at this time.
- Longer CDs allow for higher-yields in underlying investments. When banks receive deposits, they put the money to work in a variety of ways, some of which includes making investments to help pay the interest promised to depositors. The longer you commit your money, the more flexibility the bank has in making those investments. When the bank can make longer-term investments, they will generally be able to earn higher yields, but this is especially true at the moment, with the short end of the bond market yield curve at extreme lows.
- Stable capital helps banks do other types of business. Having stable capital, in the form of deposits that are committed for a fixed period of time, gives banks the resources necessary to engage in other businesses, especially lending. The financial crisis created a shortage of capital--thus necessitating the bailouts by the government--so some banks are willing to pay more to attract capital from depositors.
In short, the attractive offers for longer-term CD rates are partly a function of the normal premium for longer-term investments, and partly a function of current conditions. This creates an opportunity, but one that may not always be this compelling.
