CDs providing banks more stability

Certificates of deposit sales remain popular and continue to provide banks with more stability.

Certificates of deposit (CDs) are a very common type of deposit, said Dr. Manuel Lasaga, a clinical professor in the Department of Finance at Florida International University’s College of Business and president of Strategic Information Analysis, an economics and finance consulting firm. The way CDs work is a bank customer deposits “money in a certificate of deposit, and that amount is then basically … given maturity, whether three months, six months or a year, and typically it pays a fixed rate.”

Other types of deposits, he said, such as money market accounts and savings deposits, provide more liquidity for the customers. This is because when it comes to a time deposit, there are penalties if the customer wants to or needs to use the funds. As a result, withdrawing funds from CDs usually involves a penalty.

In a high interest rate environment, said Dr. Lasaga, “when banks choose in what direction to go, as far as their funding for them to be able to make loans and their investments, banks need to capture deposits to a large extent. There are two reasons they would need one particular type of deposit or the other, and it’s that banks need to guard their liquidity.”

Banks need deposits in order to make loans. Additionally, he said, “banks want to always have enough liquidity. If they are growing their portfolio at a faster rate, they then would be more active in attracting deposits. The other area where the bank has to make a decision on the types of deposits, when they’re going out for deposits, they have to look at the maturity that they will like in terms of their deposits, because banks also – in terms of achieving their profitability and hopefully achieving sustainable profitability – they need to manage what is called interest rate risk.”

What banks do, said Dr. Lasaga, is use the CDs, particularly of different maturities, in order to lock in certain proportions of the deposits. This allows banks to count on these funds being there while also controlling “the interest rate risk, because they will be at a fixed rate. Whether it be six months or a year, there will be a fixed rate during that time, and then it allows the bank to have more stability, given that many times it makes loans for maturities of one year and over.”

Dr. Lasaga said he believes these types of time deposits, like CDs, will continue to be seen. When interest rates start to rise, investors and depositors look into locking in some of their money “at a higher rate than what they were receiving before the rates increased because whenever the rates go up, eventually interest rates are going to start to go down. The demand for these CDs are driven by what happens to interest rates in general.”

Dr. Lasaga said he doesn’t believe any new type of deposit time instruments are going to be seen. “CDs are … the choice of depositors as far as time deposits.”