Why do certificate-of-deposit (CD) interest rates vary so widely between banks?
Banking
Asked by Question Bot07/Jul/20141 answer
1 Answer
F
Faisal Khan
Answered 07/Jul/2014
CD rates are a function of the bank's treasury and investment arm. There are various factors and variables that determine the overall CD rates that a customer will get.
The first and foremost is the cost of funds. How much does it cost the bank to borrow money to lend out (on which it will make money). This is tied in various way to the LIBOR rates and/or other equivalent rates (depending on the country you are operating out of).
Deposits also determine how CD rates would be affected. Banks have to maintain a specific threshold with themselves at all times. Depending on how the deposits are made to the bank (are they over-night, short-term, long-term), and what the cost of funds for these deposits are, the CD rates can vary. Treasury, Risk, Compliance, Investment Banking, Transaction Banking, Cash Management, et. al. all play a role in this. If you are sitting on excess deposits, but there are not enough investments for the bank to make money on, bet your bottom Dollar that the CD rates would be low. Each bank that also looks acros the banking aisle to see what the other banks and Fixed Income institutions are offering. If there are plenty of lucrative investments the bank can make, within the established risk guidelines and has adequate deposits to secure them, or it feels it can achieve more deposits based on a better deposit rate, the CD rates would be higher.
Market dynamics of the eco-system (i.e. economy) you are operating out of all matter a lot. If your CD is tied to the US Dollar in a country where the base unit is not the USD, your CD rates could be potentially higher than say the base rate you may get at a bank in New York. It is a very calculated number and is highly dependent on various factors. It is the treasury department's responsibility to calculate this CD number on a daily basis or weekly basis and propagate this throughout the bank and its sales team.
The CD rates are not quite tied into the credit quality of the bank per se. Its mostly set on the principal, that if I (the bank) get money, how will my bank invest this money, make enough money from it to pay back the depositor, make some money for the bank, cover the cost of this deposit and keep the bank in a liquid position should the instrument be cancelled or cashed out.
The first and foremost is the cost of funds. How much does it cost the bank to borrow money to lend out (on which it will make money). This is tied in various way to the LIBOR rates and/or other equivalent rates (depending on the country you are operating out of).
Deposits also determine how CD rates would be affected. Banks have to maintain a specific threshold with themselves at all times. Depending on how the deposits are made to the bank (are they over-night, short-term, long-term), and what the cost of funds for these deposits are, the CD rates can vary. Treasury, Risk, Compliance, Investment Banking, Transaction Banking, Cash Management, et. al. all play a role in this. If you are sitting on excess deposits, but there are not enough investments for the bank to make money on, bet your bottom Dollar that the CD rates would be low. Each bank that also looks acros the banking aisle to see what the other banks and Fixed Income institutions are offering. If there are plenty of lucrative investments the bank can make, within the established risk guidelines and has adequate deposits to secure them, or it feels it can achieve more deposits based on a better deposit rate, the CD rates would be higher.
Market dynamics of the eco-system (i.e. economy) you are operating out of all matter a lot. If your CD is tied to the US Dollar in a country where the base unit is not the USD, your CD rates could be potentially higher than say the base rate you may get at a bank in New York. It is a very calculated number and is highly dependent on various factors. It is the treasury department's responsibility to calculate this CD number on a daily basis or weekly basis and propagate this throughout the bank and its sales team.
The CD rates are not quite tied into the credit quality of the bank per se. Its mostly set on the principal, that if I (the bank) get money, how will my bank invest this money, make enough money from it to pay back the depositor, make some money for the bank, cover the cost of this deposit and keep the bank in a liquid position should the instrument be cancelled or cashed out.