Why Banks Should Limit Their CD Offerings

As a general statement, banks offer too many options for certificates of deposits (CDs). Consider that the average bank offers 12 different maturities, some “specials,” plus several different tiers of pricing within each maturity. We have seen banks with as many as 42 different CD options which is inefficient for every party. The problem is too many CD offerings can increase a bank’s cost, confuse its customers and, worst of all – damage its overall deposit performance. In this article, we look at a counterintuitive strategy for increasing deposit performance.

Banks That Offer Limited CDs

Citizens Bank, for example, offers just two CDs, three if you are OK with only dealing with the bank online (below). This limited number of offerings presents essentially two choices for customers: An option that is just over one-year and a three-year option. Citizens knows that these CDs cover the bulk of customer desires. 

The Customer’s Point of View

Ask a bank why they offer so many CD options, and you either get, “That is how we have always done it,” which is never a good answer, or you get, “Because the customer wants choices.”

The reality is few customers need to build a “cash flow ladder,” or need to structure their CD investments to achieve a certain duration. In no focus group or customer survey have we ever heard that a bank was chosen because of their breadth of CD offerings. While customers complain about the price of CDs, we have never heard of a complaint where the customer wanted a five-year or a nine-month CD and the bank didn’t have it.

Usually, it is a digital thought process - the customer either wants their money liquid or they don’t. Few care enough about the term structure of interest rates and where they would like interest rate exposure. A customer that cares that much about the shape of the yield curve either keeps their investment in bonds or demands such a high rate on their CDs that they are likely one of your worst deposit customers due to their  interest rate sensitivity.

Left to their own devices, bank customers naturally gravitate to the one to three year part of the yield curve. This is usually the time horizon that most households and business plan when it comes to thinking about their bank-kept liquidity. For customers to go out longer than three years they often need to be enticed with a higher rate which is why you see much greater premiums for longer maturities (below). 

Very few banks have a customer base that will naturally want to invest their money for four years or longer unless there is a premium to the rate. Conversely, bank customers are often satisfied with a money market account for periods less than a year.

The Problem With Longer Maturity CDs

Unless a CD is priced correctly, or a bank is confident in their profitable product cross-sell ability from a CD, which few banks are, driving franchise value from CDs is extremely difficult.. To create value, CDs need to be priced below Libor/swap rates, or at least wholesale liability rates (brokered CDs, FHLB advances, etc.). As shown above, this is difficult to do.

Banks that pay above wholesale rates are better off using wholesale money temporarily as that is a less expensive option; not only  because of the stated interest expense but also because of the lack of cannibalization. Offering a higher-priced five-year CD in your service area, for example, makes the entire deposit base more interest rate sensitive (price elastic). Every time a CD comes to maturity, the customer will look around for various options and usually make a decision based on the rate. The more choices you have, the greater the tendency there is to teach your customers and your employees that the rate is important.

This also explains why banks with a higher percentage of CD liabilities compared to average trade at lower multiples and generally underperform vs. bank performance indices.

The Problem With Shorter Maturity CDs

For shorter CD maturities, the pricing equation for a bank is often worse. By offering a CD shorter than a year, a bank almost always will cannibalize their money market account. As such, the mere presence of having a shorter maturity CD impacts both the price and the interest sensitivity. Remove the  CDs that are shorter than a year and a bank will often not only be able to lower the cost of their money market accounts, but also find that more customers will park money there increasing the duration and decreasing price elasticity. 

Simplify Your CD Offerings

By reducing your shorter and longer term CDs, banks can reduce cost by not having to manage various maturities each with their different pricing tiers based on account balance or cross-product use. Explaining CD options, opening the CD account, managing the core system, contacting customers, dealing with rollovers and solving problems cost banks an average of $67 per year per CD account.

Reduce the number of CD accounts outstanding, and you will reduce the cost. While not a huge cost reduction for most banks, it does help on the margin, particularly given the fact that most banks pay this extra cost to achieve WORSE liability performance with their CD offerings. 

While every bank has a different customer base and set of liability goals, most banks would benefit by reducing the number of CD offerings to just two or three different maturities. The active management of a liability portfolio is one of the underutilized ways that banks can quickly enhance their bottom line and improve franchise value.

Don’t take our word for it, take a branch or your online effort and test market a simplified CD structure. A rising rate environment is an excellent time to do this as we are near the period in the rate cycle where we see a greater number of pricing mistakes from banks. When yields were low, few customers and few banks paid attention to their liability structure as mistakes didn’t matter much; now, given the higher rates, mistakes can have far-reaching consequences. 

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