Earlier this year, the Fed abolished the reserve requirement. My understanding was that the motivation for banks offering CDs was because the Fed didn't impose reserve requirements on CDs, so banks could lend out more of deposits held as CDs than deposits held in other, lower interest forms. Given that CDs no longer provide an advantage to banks over normal accounts in this respect any longer, why do banks have any incentive to keep offering CDs? Is there another reason banks offer CDs?
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$\begingroup$ the motivation for banks offering CDs was because the Fed didn't impose reserve requirements on CDs -- I'm not sure if this is correct. That may have been a small motivation, but the key motivation was always that CDs offered longer-term funding (as mentioned in Brian Romanchuk's answer below). $\endgroup$– user18Sep 24, 2020 at 1:42
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2 Answers
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Demand deposits might be cheaper, but they can disappear due to withdrawals. Banks also need stable sources of longer-term funding to match against their illiquid assets. Holding reserves is only of limited economic importance relative to the need to widen funding sources.
CD’s are cheap relative to other sources of term funding. It would be very hard to imagine that they will be phased out.
answered Sep 23, 2020 at 23:56
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Banks must manage the flow of reserves to settle payments via the inter-bank payment process. When a bank makes a new loan it debits portfolio asset for an increase and credits transaction deposits (checking account) of the borrower for an increase. If borrower spends funds to a customer of another bank then reserve balances issued by Fed will flow to the other bank (reserves tag along to settle net inter-bank deposit transfers). The bank must force a flow of reserves into the bank to offset the flows going out of the bank. Banks pay interest on liabilities to manage the inter-bank flow of reserves. Certificates of Deposit are just one of many instruments banks use to manage the flow of reserves.
