Rate hikes will drive change in long-term deposits

Time deposits with daily redemption options stand to materially improve value for both depositors and financial institutions.

Insured time deposits are seen as being the same products that were offered when the minivan was first introduced.  How can this be when we consider that enhanced product design is such a key part of every industry today?

The simple proposition for the 1980s time depositor was to get a higher interest rate in exchange for committing to a longer term for the financial institution to use their funds.  Financial institutions at that time issued simple, but somewhat random, early-withdrawal penalties that were required to fall within the boundaries of regulatory guidelines.

For financial institutions today, a material increase in market interest rates will lead depositors to demand some pricing response.  It is clear that, to appease depositors, the financial institutions will seek to offer discrete accounts rather than reprice large portfolios of non-maturing deposits.

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However, this time will be different because the time deposits offered by some financial institutions will provide a daily redemption option.  This approach will address the major barrier to embracing time deposits – the expectation of locking up money in a CD.  In the spirit of “buy now, pay later,” time deposits with daily redemption options will materially improve the value to both depositors and financial institutions.

Who would have thought that the evolution of layaway and credit card purchases would produce the current chapter of “buy now, pay later?”  Think of the huge market valuations of the BNPL fintechs today that didn’t settle for the idea that everything that could be done in the arena of consumer payments had already been accomplished.  They looked at the industry from the eyes of the consumer and took the challenge of redesigning the experience so consumers could get more of what they wanted confidently and conveniently.

Now we can predict a parallel in the previously static arena of time-deposit product design. What if we broke away from the paradigm of locking up money with “substantial penalties for early withdrawal” and offered a simple and convenient digital daily redemption option to time-deposit holders?

A daily redemption option would enhance the consumer’s access to their funds at a discount rate set by your financial institution’s pricing team. Your financial institution would merely be unleashing the value of liquidity in these time-deposit contracts that previously has been off the table with traditional static and arbitrary early-withdrawal penalties.  Ask yourself this in today’s world: How many other static and arbitrary terms and conditions are surviving as consumers are now equipped and empowered to consider all their options with the power of today’s mobile devices in their hands?

Remember pricing deposits in 2017-2019?  If you don’t want to participate in a deposit price war, where you could be forced to tout interest rates as we enter the coming rising interest rate cycle, then consider implementing an improved product offering that is universally more appreciated by depositors. Depositors have been shown to always select daily redemption options if given the choice.  Wouldn’t you if you were the depositor?  So, why not create the option for your depositors?

If you think it would create more interest-rate risk for your financial institution, I would encourage you to think about the risk that is built into the current approach to early-withdrawal penalties. The optionality in these static and arbitrary penalties already creates interest-rate risk.  Market value, early-withdrawal penalties do not create any additional interest-rate risk.

So, with no additional risk and a better product offering for depositors, you would be in the desirable position of being able to pay less while getting more deposits.  There may be no better time to introduce this new approach for long-term savers than when interest rates are rising in 2022, and you begin to again compete for deposit funds.  Any deposit interest rates you offer from today forward can be reduced because depositors value the daily redemption option embedded in time deposits with enhanced withdrawal options.

If this positive opportunity to enhance value for your depositors without increasing your cost of funds isn’t enough motivation, consider the consequences of your digital and neobank competitors implementing it ahead of you.

Neil Stanley is founder and CEO at The CorePoint.