Question

97. If the depository institution were to attract money away from longer-term CDs into shorter-term deposit accounts, explain why this would be beneficial and, at the same time, raise the risk of the institution.

Answer 1

If the depository institutions were to attract the money away from longer-term CDs to the short-term deposit account, it would be beneficial from the perspective of increasing the liquidity for the banks as bank will have access to more capital at cheaper source. The banks can use that fund for providing loan for commercial purposes and earn income on that. Since these deposits are being moving from the long-term CD to the short-term CD the bank can be assured that the maturity of this deposits would be slightly longer than the normal short-term deposits. The bank can use this to realign its asset liability management practices. The risk of this is that it will raise the cost of funds for CDs. If banks have to attract those funds then they will have to provide more interest return to the depositor to attract them, this might increase the cost for them. Since these deposits would not be like CDs so if the customer withdraws the money in short-term banks might face liquidity issues.