Why Are Banks Pushing CDs All of a Sudden?
Has your bank tried to sell you a CD lately?
A CD or Certificate of Deposit is a “safe” investment option banks market to their customers. In exchange for locking your money up with them for a specific period of time, they’ll compensate you with an interest rate that’s higher than what you might otherwise get in a regular savings account.
Sometimes that interest rate beats the annual rate of inflation. Most of the time it doesn’t. A CD is really just a glorified checking account that you surrender access to for a period of time.
Last week I was back home in New York when I had lunch with an old coworker. We both did stints at a local community bank. She was telling me about the bank’s recent CD campaign and how much money they hauled in.
“$13 million. Can you believe it?”
To be honest, I couldn’t.
For context: the area I’m from is currently auctioning off a 50,000-square-foot industrial building — equivalent in size to an entire city block — for $5 per square foot.
You can hardly find a starter home in America for $250,000 let alone AN ENTIRE CITY BLOCK.
(P.S. There’s a link to my Buy Me a Coffee profile at the bottom of this article. If you’ve ever wanted to help a writer fulfill her lifelong dream of buying a city block, now’s your chance.)
I’m going to be straightforward here. I didn’t know people from that part of Upstate New York had that much money lying around to hand over to a bank in the form of CDs.
After lunch that day, I went to the local credit union where I had been a member since the ripe old age of 12. I no longer live in New York and have no intention of returning anytime soon. I decided it was time to close my accounts.
As the teller went through her account closure checklist I spotted marketing collateral in the lobby advertising a new marketing campaign.
Just like the bank my coworker told me about, the credit union was also offering CDs at a whopping 2% interest.
Ok, two financial institutions in a socioeconomically depressed area are offering CDs at the same time. So what?
It’s a little after 10 pm right now and I thought I would be productive before bed and clear my inbox. As I was scrolling through messages I clicked on this marketing email from a bank I’m not actually a member of. I just have a 0% APR credit card with them.
Call me a conspiracy theorist, but what are the chances that a community bank, a small credit union, and a national bank are pushing CDs at the same time?
Now you might be thinking, Amanda this isn’t a big deal. Banks offer CDs all the time.
Really? Because I can’t recall a single time in my adult life when I’ve been propositioned by a bank to stake my money in a CD.
I honest to God thought that was only something elderly people did.
There is definitely something fishy afoot…
How Banks Make Money
Before I dive deeper into this I first have to tell you how banks make money. But before I can do that I have to shatter a myth you probably believe about banks.
They are not a public good. A bank is not the same thing as a library or a fire department.
Banks are in the business of selling money.
They are no different than McDonald’s. Hence why many banks have branches near McDonald’s or other similarly-fashioned shopping plazas.
What’s worse: banks sell money with the intent of making a profit. Specifically, they’re in the business of selling you debt.
Because let’s acknowledge the elephant in the room: banks don’t make money when you’re financially healthy.
So regardless of what your banker has told you, they aren’t lending you money to buy your dream home or take a much-needed vacation. They are taking advantage of your emotions the same way McDonald’s takes advantage of your taste buds.
Banks make a profit from the difference between interest charged on loans and interest paid on deposits.
All the money sitting in your checking and savings account is considered a deposit. Those deposits are used by banks to essentially redistribute to other people in the form of loans. They collect interest from the borrower and pay you pennies for the privilege of holding your money. The difference is what they keep for themselves as profit.
Here’s an example:
Let’s say Sally and Susie go to the bank. Sally goes first and deposits $100 into her savings account. Her account earns interest at a rate of 0.10% APY.
The $100 she deposits doesn’t physically sit in her account though. It’s entered into a spreadsheet and the cash is used for other business activities — like lending.
Susie goes to the bank after Sally and asks to take out a loan for $100. The money Sally deposited earlier in the day is used to provide the cash for Susie’s loan. She takes the money and agrees to repay it at an interest rate of 5%.
The profit the bank makes is the difference between 5% minus 0.10% or 4.9%.
If you think about it, this whole proposition is kind of bonkers. They aren’t running a Gigafactory rolling new Teslas off an assembly line. And they aren’t providing a specialized service.
Banks literally move data from one cell in a spreadsheet to another. In exchange for that tremendous contribution to society, they are rewarded with a handsome profit.
Yes, I am rolling my eyes through your screen…
Why Banks Want Your Cash
This brings me back to CDs.
Why does it seem like every bank is encouraging you to deposit your money right now?
Let’s go back to the example of Susie and Sally above. What if Susie still wants to borrow $100 but Sally didn’t go into the bank earlier that day to deposit her money? Where does the bank get the money to give to Susie?
The Fed.
You and I largely experience banking as the place where we buy err I mean “borrow” money. We don’t experience higher levels of banking that take place between banks. So we aren’t aware that such a different type of banking even exists.
Commercial banks are required to keep a certain amount of money on hand, called a reserve. When banks don’t have the funds they need to meet their reserve obligation they borrow from the Federal Reserve.
The Fed doesn’t want to lend banks money. It wants them to source it from the market. AKA people like you and me.
To dissuade banks from borrowing money, the Fed charges a higher interest rate. It’s more affordable for banks to use deposit funds at a 0.10% APY than it is to borrow from the Fed whose rates could top 4% by the end of the year.
This is why banks are pushing CDs right now. Even at 2%, your money is still cheaper than the Feds.
Final Thoughts
Are CDs inherently a bad thing? Should you avoid them?
No. And that’s not what I’m advocating here.
What I am advocating is that you should be aware of the game we’re all playing.
Banks are in the business of selling money. And you are in the business of selling yours.
If you decide to sell it to a bank you should try to get the best return on your investment.
Even at 2% interest, a CD barely competes with most high-yield savings accounts. This is important because you get the same financial benefit without having to lock up your cash for a period of time.
That means if the zombie apocalypse happens tomorrow you can withdraw your money from a high-yield savings account. You can’t with a CD.
And even before this current bout of inflation, you would still lose on a CD. The average annual rate of inflation rate has been between 3–4% for the past few decades.
A CD isn’t even keeping up with that. Once you liquidate a CD your money has lost more in purchasing power than it’s gained in interest.
Just remember: if a bank seems like it’s trying to sell you on something that’s because they are.
Your financial interests aren’t their priority. Their profit margin is.
Bank safe friends. It’s a scary world out there.
