Bank time deposits (Certificates of deposits) are some of the highest yielding government guaranteed investments available today.
In general there are three types of bank deposits: checking accounts, savings accounts and time deposits. All of these accounts have equal standing as obligations of the bank, and almost all (96 percent) of them are insured up to $10,000 by the Federal Deposit Insurance Corporation (FDIC). In 28 years there have been 440 commercial bank failures but only one serious savings bank failure.
The only real difference between checking and savings accounts on the one hand, and time deposits on the other, is that the former can be drawn out immediately and the latter are deposits for a period of timegenerally three, six, nine or twelve months. For the average small or medium size investor this difference is not significant. He builds up his account through savings and he draws out only in emergencies and to make an important purchase, such as a car or a home.
The rate of interest you receive on bank time deposits is presently between 4.7 percent per annum and 6 percent. Banks pay you up to 3 percent on time deposits, sometimes less.* How then is the rate of 4.7 percent to 6 percent possible?
* A typical rate structure is 2 percent on deposits left in the bank from 30 to 89 days, 2.5 percent on deposits from 90 days to six months and 3 percent on deposits over six months.
When business organizations borrow from banks they are usually required to keep deposits in the bank. It is paradoxical but true that if a corporation borrows $100,000 from a bank at say 6 percent per year, it is expected to keep on deposit 20 percent of the loanin this case $20,000.
If the bank makes this requirement, and it usually does, the 6 percent interest on $100,000 ($6,000) is really $6,000 interest on $80,000 actually available to the corporation to use in its business. Six thousand dollars on $80,000 is the real interest rate paid by the corporation7.5 percent. The 20 percent "compensating balance" is a device used by banks to raise the interest rate charged to businesses while giving the semblance of a low interest rate. Sometimes the business organization is paid interest by the bank up to 3 percent on the compensating balance, sometimes not.
It is obviously to the interest of corporations to use this money in their business. Otherwise they would not borrow from the banks. You, as the investor, can sometimes make a time deposit by saying to a corporation, "I will put in your 20 percent compensating balance (or a part of it) so that you can use your money in your business. I will, of course, agree to keep my money on deposit for a period of time. Otherwise if I draw it out the bank will require you to put back your 20 percent compensating balance. Now, since the bank pays me 3 percent on these time deposits you pay me another 2 percent. Isn't that good business?"
In some cases the bank pays less than 3 percent on time deposits, so the corporation has to pay more to make up the 5 percent that you, the investor, want.