Certificates of Deposit – A source of “long” money for banks
The problem of the lack of long-term resources in Russian banks has long been discussed at various levels of state structures. One of the effective ways to solve it is the introduction of certificates of deposit, says Vasily Solodkov, Candidate of Economic Sciences, Professor, Director of the HSE Banking Institute.
Can you explain what the problem is?
The bottom line is that the economy lacks “long” money. In the modern period of development of the domestic economy, the problem of long-term resources in the banking system of Russia is more acute than ever. Over the more than 30-year history of the development of the Russian banking system, the problem of long stable liabilities at a fixed price has not been resolved – although according to experts, there is a simple and market-oriented solution: a certificate of deposit. We need cheap and “long” money – for lending to the economy and further reduction of inflation – and competitive bank rates. To solve at least the first of these tasks – that is, to obtain cheap and “long” money – such a tool as a certificate of deposit can be used very fruitfully. But we need not the one that is now used in the Russian economy, but its prototype or original, which was created in America.
It is worth reminding the readers of Capital Ideas of what these certificates are.
In short, American certificates of deposit (CD) are a type of term deposit – not a security, as they are usually considered in Russia. At the same time, in the United States there is no distinction between individuals and legal entities, and CDs are used by both.
What is the difference between the American and Russian versions of a certificate of deposit?
Since in the US it is a type of term deposit, and not a security like ours, there is a significant difference. First, in the United States, the bank itself sets the yield and maturity of such a certificate. Here it is a security with predetermined parameters, the issue of which must be registered. Since in the US this is a type of deposit, it is insured as a regular deposit, in the amount of 250 thousand US dollars. Deposit (savings) certificates, like any securities in the Russian Federation, do not fall under the insurance system.
CDs are convenient for banks in the United States, as they allow you to have liabilities with a fixed price for the entire period of validity of the certificate. In return, the buyer of the CD receives a higher percentage on it than he would have received on a regular deposit. In addition, they give the buyer an additional advantage: it is possible to sell the certificate on the secondary market, in the event that the buyer needs money before the end of the CD’s validity period. Obviously, the interests of the bank do not suffer, since there is simply a transfer of ownership rights between the holders of the CD.
In addition, American CDs solve the problem for banks of the management of risks, including from interest rates. Obviously, the longer the validity of the certificate, the greater the risk arises for its issuer; for example, interest rates can change significantly over 10 years, and not always to the benefit of the bank. If the bank is concerned about the issue of regulating interest rate risk, then it issues a CD which is referred to as “callable”: a certificate with the possibility of redemption by the bank. That is, if the bank sees that the interest rate is changing contrary to its interests, it simply buys back such a CD from its owner. In return, at the initial sale of such a certificate, the bank sets a higher interest rate on it than on a conventional CD without the right of redemption.
What are the other advantages of certificates of deposit?
In the United States, they solve another problem, the consideration of which in Russia has not even begun. For example, if a client has 14 million rubles, and the DIA insures only 1.4 million, then he needs to open accounts in 11 banks so that both the deposit principal itself and interest on it are insured. This means that in accordance with the limit of the insurance system, you need to physically visit 11 banks, open accounts there and put funds there. Obviously, after the expiration of the deposits, there will be a new trip to 11 banks, or money transfers, the cost of which can be comparable to the interest income received by the client for the entire term of the deposit.
In the U.S., banks that open certificates of deposit are organized into an association of banks operating on the interbank market, which make their insurance limits available to each other. In this case, if a client comes to a bank with 10 times more money than the American deposit insurance system covers, then the bank that is part of such an association contacts another 10 banks which are members of the association, and each of them issues a CD, within the coverage of the insurance system, making corresponding deductions. Thus, without unnecessary travel to banks and loss of time, the client receives a fully insured CD, the amount of which is 10 times higher than the amount of insurance coverage established for 1 client in 1 bank. Of course, you could physically go around to 11 banks, as is done in the Russian Federation, but why? You have to value your time and your clients’ time.
Instead of American certificates of deposit, Russian legislators created Russian savings certificates, which as securities are not part of the insurance system. Naturally, the interest of the public in such a security is near to zero, since it is essentially an irrevocable deposit – and due to its lack of popularity, it cannot solve the problem of long liabilities. Under these conditions, every year there is a clamor, with either banking associations or the central bank itself demanding the creation of irrevocable deposits. In the event of the appearance of such deposits, they obviously await the fate of Russian savings certificates – since for the bank they will lead to interest rate risk, and for the client, to the impossibility of accessing their funds when the need arises (not to mention their own interest risk, which is not hedged in any way in Russia). Thus, the certificate of deposit in its original form – not “improved” by Russian legislation – is a much better, market means of creating long liabilities than its non-market counterpart, the irrevocable deposit.
Since we are talking about the search for “long” money, then could one of its “free-flowing” sources be the state?
It’s hard to believe that. The fact is that the state is the least effective of all possible investors. Given that there are not many accumulations of resources in the Russian economy, other sources should be sought. Nor can the Pension Fund of Russia become such a source. After the reform in Russia, all incentives for the formation of pension savings disappeared.