Under normal conditions, bankers offer higher yields on CDs to lock in funds for longer-terms. So, it is intuitive that there should be a penalty for early withdrawal to keep those funds in place on the bank’s balance sheet. That is, until interest rates fall dramatically and alternative funding sources can readily replace those deposits for much lower costs without adversely impacting interest rate risk.
As interest rates fell in 2020, a few bankers realized they could “refinance” their highest-cost obligations to long-term depositors for the same terms at much lower interest expense.
Most depositors pass when they have the chance to redeem early, but when early withdrawal with extra interest is offered, some depositors take the deal. Why depends on the depositor. Mathematically, the extra interest at the point of early withdrawal is not enough to make up for the interest that would have been paid over the life of the term deposit account. But the wants and needs of depositors are not simple, homogeneous or static.
By allowing expensive deposits to exit in this deposit-rich environment, banks expand their opportunity to attract and retain more of the properly priced deposits available in today’s market. This helps team members get beyond the simplistic notion that more deposits are always better, regardless of cost. Shedding unprofitable deposits in favor of profitable ones is something everyone in a financial institution can agree on.
Executing this financial innovation can be as simple as sending a private invitation to a term deposit holder thanking them for the opportunity to be their financial institution of choice; expressing that the bank’s healthy financial footing allows it to make offers that go beyond the norm for the industry; and offering them extra interest if they choose to redeem their account early.
In a time where resources have been stretched and challenged, sending out these early withdrawal invitation letters to a select group of long-term depositors has proven to be a light operational burden.
The financial impact is based on several factors: the volume of longer-term deposits on the books before interest rates plunged in March 2020; the share of the mark-to-market adjustment offered to the depositors; and the take rate by the depositors. That said, we are unaware of any financial institution making offers that concluded that the financial benefits to them were not worth the effort involved. The juice was definitely worth the squeeze.
As time passes, the mark-to-market adjustments decline. A simple example, however, demonstrates financial opportunities that remain quite viable in the first quarter of 2021.
For example, a $100,000 deposit booked in June 2019 at 2 percent with a five-year term will cost the financial institution around $4,300 more than if that rate was reset to today’s interest rates. Even after sharing part of the $4,300 saved with the depositor, the reward to the financial institution is quite attractive.
Reg D is quite simple and clear regarding early withdrawal penalties.
“The early withdrawal penalty must be at least seven days’ simple interest on amounts withdrawn within the first six days after deposit (or within six days after the most recent partial withdrawal). If funds are withdrawn more than six days after the date of deposit or more than six days after the most recent partial withdrawal, no interest penalty is required under Regulation D.”
A well-conceived, early withdrawal incentive approach abides nicely with this regulation. In addition to offering some early withdrawal incentives, these campaigns typically state that waivers of early withdrawal penalties are limited to time deposits made before March 11, 2020.
In addition, the accountholder is protected by UDAAP (unfair, deceptive or abusive acts or practices) provisions. Banks continually make privately negotiated pricing offers to depositors based on many factors. Financial institutions offering early withdrawal incentives make no effort to prove the benefits of the early withdrawal. It is merely another option that depositors previously didn’t have.
Depositors either like the deal and take it, or they don’t. How could it be unfair or deceptive to allow people a liquidity option to access their own money? Depositors electing to accept some additional interest from the financial institution and redeeming their money that they would have ultimately received some months later are taking no new risk.
Sending depositors a private invitation that gives them more options is a winning approach. It is, after all, their money and if they want it early, a financial institution can profit nicely by helping depositors access their money more promptly than originally planned.
Neil Stanley is founder and CEO at The CorePoint.