-- A small community bank in western Iowa has introduced a new type of certificate of deposit that sometimes rewards early withdrawal, and only penalizes them if interest rates rise.
Treynor State Bank has cautiously rolled out the product, called the CDtwo, in the past year, to three or four customers, said Josh Guttau, the bank's president and chief financial officer. The bank is the only one in the U.S. that offers the product, which was developed and trademarked by Neil Stanley, a consultant at Bank Performance Strategies in Omaha.
It functions like a conventional CD, except that if interest rates fall after it's purchased, the customer can cash in and be paid extra for doing so. With a conventional CD, an early cash-out means a penalty. Interest rates are generally the same as rates for regular CDs, and the CDtwo can be purcahased in terms from 18 months to five years.
Other banks across the U.S. have begun offering CDs that let customers cash out without a penalty, but this is the probably the first CD that offers a reward, said Carol Kaplan, a spokeswoman for the American Bankers Association.
"We are aware of products where you can get let out early withour a penalty, but we have not heard of a case where you're actually rewarded for doing so," Kaplan said. Stanley submitted a patent application in June.
Why would a bank do this? To attract new customers, have a more stable base of deposits, and better manage interest-rate risk, said Guttau.
"There is no benefit from a financial standpoint," Guttau said. "The win for us, that doesn't cost the consumer anything, is that we have a differentiated product, we can attract a clientele that might not be excited about a traditional CD."
"Differentiated" for a bank is like "diversity" from an investor's perspective. Generally, banks want to hold customer money for longer, rather than shorter, periods of time. Longer maturities on a CD help bankers better predict what they have to pay their customers in interest, and guarantees the money will be there to loan out for a specific period of time.
The CDtwo, because it encourages customers toward deposits with longer maturities, is helpful for risk management. For customers, the product makes more sense than a regular CD because the only time the customer is penalized for cashing out is when interest rates rise dramatically.
If interest rates drop or stay constant, it's to the bank's advantage for the customer to cash out, so under this product, the bank offers a bonus to customers who pull out early.
"Rates could even go up, and you still wouldn't have a penalty," Guttau said.
That's because as a CD gets closer to maturity, its interest rate becomes more valuable to the customer and more of a burden to the bank. Three years into a five-year CD, the customer in effect has a two-year CD at five-year rates. The banker might prefer to cash out the CDtwo, find a new way to deposit the money, and pay the customer a portion of the savings.