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Banks Should Make It Harder to Withdraw CDs Early

There is a very old saying that what goes up must come down. The reverse is also true in regard to current interest rates on certificates of deposit.

On July 1, 2006, the average rate on a six-month CD was 5.54% and on July 1, 2009, the average rate was 0.50%. This represents over a 500-basis-point decrease in 36 months.

In the past 60 days, we have begun to see an increase in interest rates. The question today is how fast and how far will rates increase.

Rapidly increasing rates can have a very significant impact on a bank's asset/liability management, net interest margin and bottom-line profitability.

Many years ago the Federal Reserve eliminated the regulations regarding early-withdrawal penalties on CDs. Today, banks can establish any structure for their early-withdrawal penalty. However, some banks still charge a one-month penalty on a CD of one year or less and a three-month penalty on CDs over one year.

On July 1, 1980, the average rate on a six-month CD was 8.73% and in July 1, 1981 it was 17.40% over an 800-basis-point increase in 12 months. Can this happen again, but starting at a lower initial interest rate?

During this 12-month period, customers were coming to the bank and cashing CDs they had purchased only 30 to 60 days prior because it was cost effective to pay the early-withdrawal penalty and reinvest at a higher interest rate.

Most customers do not ask about a bank's early-withdrawal penalty when purchasing a CD. Therefore, it is not usually a competitive issue among banks.

Banks need to consider the following minimum structure for their early-withdrawal penalty: a three-month penalty on CDs of less than 12 months, a six-month penalty on CDs of 12 to 23 months and a 12-month penalty on CDs issued for 24 months and longer. An alternative would be a penalty equal to 50% of the term of the CD, i.e. 18-month penalty on a 36-month CD.

It should not be easily cost effective to cash any CD prior to maturity.

Existing CD customers should be sent a notice concerning the changes in the early-withdrawal penalty that will become effective when their CD renews.

We all know that controlling a bank's net interest margin is the single most important factor in determining a bank's overall profitability. Adjust your early-withdrawal penalties today.

Lynn A. David is president of Community Bank Consulting Services and has been a consultant to financial institutions for over 27 years.


(11) Comments



Comments (11)
Here is a different approach. Instead of putting up barriers why don't we create an opportunity? Here is a recent news story...

What would be the negative consequences of this offering? Can't find any? Can you see where this is a more positive way to solve the penalty deficiency issue?
Posted by Neil Stanley | Saturday, October 26 2013 at 2:12PM ET
Here is a different approach. Instead of putting up barriers why don't we create an opportunity? Here is a recent news story...

What would be the negative consequences of this offering? Can't find any? Can you see where this is a more positive way to solve the penalty deficiency issue?
Posted by Neil Stanley | Saturday, October 26 2013 at 2:12PM ET
-100%. Cross selling opportunities explode. Market doesn't creat demand, demand creates the market.

I can show banks how to double, maybe triple the bottom line with simple adjustments. Educate consumers how to get more from the tools you sell them and they will beat down your doors. Instead of tripping over dollars to pick up nickles you could scoop up dollars with every step. And your customers will help you along the way because you have improved their financial lives like never before. All you bank execs need to do is learn a few new tricks and in turn you will change the financial landscape of this country the right direction this time. Build a stonger consumer and you build a stronger institution. That's all I'm saying.
Posted by Bill Westrom | Thursday, September 12 2013 at 5:22PM ET
stonecastle, technically you are 100% correct; deposits are a loan to the institution. But here's the kicker; the terms are set by the borrower. It is the only model on the planet the functions this way. Don't get me wrong, I get it; its how the model was set up and I'm not disparaging the banking industry for establishing/maintaining a very, very successful and profitable model. However, the model is proving itself to be flawed. The benefits are so one sided and the penalties (to the 'lender')are so oppressive that the foundation (the consumer) by which it is built is crumbling and/or no longer capable of supporting the structure/model. All I am saying is the model has to be tweaked. I've said it many, many times here; build a financilly stronger consumer and you build a stronger institution/industry.

Public banking has proven to be a better banking model (see Bank of ND)because the consumer and their community are a direct benefactor of the profit model at the street level, offset accounting principles provide greater mutual benefit to both consumer and institution and all that is required is slight reprogramming changes from the IT department. Educating depositors & borrowers to implement equity optimization techniques can/will/does increase share of wallet to 75
Posted by Bill Westrom | Thursday, September 12 2013 at 5:11PM ET

In fact, the depositor is lending its cash to the bank in return for an expected rate of return. If not, then why not place your funds into a demand deposit account for a slightly lower rate of return but have the ability to retrieve your funds at any moment. The reason is because the depositor wishes to receive a higher rate for "lending" their money to the bank for a specific period of time. Hence, I think there is a very narrow definition of lending being used here.
Posted by stonecastle | Thursday, September 12 2013 at 4:09PM ET
Stoncastle, the depositor is not (intentioanlly) in the lending business. I agree is would be a double standard of if was lender against lender, but were talking about (what the customer beleives to be) an investment vehicle. Penalize a customer for fiscal irresponsiblity (overdraft), but don't penalize them for trying to do the right thing for themselves.

Mr. Neil Stanley, I would like to talk with you. I can be reached at 352-232-1751.
Posted by Bill Westrom | Thursday, September 12 2013 at 10:09AM ET
But when a bank lends a homeowner or business money, I assume you are OK with the bank then having the ability to request it's money back when it has the opportunity to reinvest at a higher rate?

I assume you would say "no", and hence, wouldn't this be a double standard? When a bank customer takes funds from the bank in return for the bank being paid a rate of return for the risk that the borrower defaults, why must the bank be "locked" into keeping these funds with the customer? The answer is, because it is a contract into which two parties willingly entered.
Posted by stonecastle | Thursday, September 12 2013 at 9:33AM ET
It's never black or white. There are certain things banks must do to ensure their viability. There are also certain things some banks do just to be greedy. This one could go either way depending on the severity of the penalties and the specific need of the bank based on their asset liability modeling. But I think most would agree that 3 months interest penalty on a 60 month CD is rediculously low.
Posted by kksays | Thursday, September 12 2013 at 9:30AM ET
Lynn, you are 100% on the mark with respect to addressing the bankers' interest in this regard. Your approach clearly protects the banks' earnings and capital. However, there is more to this story. Where is the value to the depositor? Raising the penalties alone will be viewed as just another form of bankers keeping customers "down". Simply adding more fees and penalties to banking will move banking dangerously toward irrelevance. We have to move to a new paradigm of unleashing mutual value rather than merely tilting the table so that the banks get the best portions and the customers get the left-overs.

Listen to Bill Westrom's voice here. He outlines the future of the adversarial banker. Actually both Lynn and Bill are right. On the surface their comments seem incompatible. However, if you go beyond the superficial conclusions of a zero-sum game you will see the opportunities. A similar confrontation occurred when digital technology brought dramatic changes to the music industry. Digital delivery threatened many of the players and they sought to take defensive measures. But, the will of the customer cannot be dismissed. The question to ask here is....How can bankers who are confronted with this situation focus less on building barriers and focus more on unleashing value for the people who matter the most - the people bankers serve? Therefore, our client financial institutions have highly refined exclusive initiatives in place now to help depositors refinance their deposits rather than holding them back. Good for the depositors, good for the banks, and good for the front line bankers who deliver these windfall opportunities!
Posted by Neil Stanley | Thursday, September 12 2013 at 12:14AM ET
This is the epitomy of the dectructive nature of the banking industry; penalize the customer to regain ownership of THEIR money. When a consumer grants a bank the privilage of their patronage the consumer becomes a victim of the banks profit model. The arrogance of your percieved ownership of our deposits is appauling. You should all consider yourself lucky that anyone deposits their money in your coffers. If every American wasn't so doped up on 'convenience' you would all be out of business tomorrow. You provide NO financial benefit to the consumer beyond convenience. Zero, zilch, nada. You're just a service provider. Financial institution? Only for your own gain. If just 50% of the public cashed their check this Friday instead of depositing their check the financial collapse of 2008 would look like a grade school four square game. You people should figure out who is buttering your bread becasue you aren't buttering the publics. Its disgusting. You better pray the public doesn't get smart and figure it out.
Posted by Bill Westrom | Wednesday, September 11 2013 at 5:05PM ET
This could raise margins in the short term. However, a rational customer would be expected to be less inclined to purchase a CD from an institution that is perceived to penalize her for doing business with the institution, and perhaps less inclined to do business with the institution at all.
Posted by | Wednesday, September 11 2013 at 5:04PM ET
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