 |
Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Why care about bank safety
ratings?
Dear Dr. Don,
What should one do if they buy a CD (or CDs) in
a bank with a certain rating and during the course of the CD term
the bank's rating drops? (I'm using the Safe and Sound rating here.)
The bank in question now has a 2*G rating. Should I take out my dough
and pay a penalty?
Also does the FDIC insure the interest on my CD or
just the CD itself? I have read that if a bank fails, many times
another bank assumes the assets and the transfer is easy. A lot
of questions, I know, but any advice would be helpful.
Thanks,
Nick Nickels
Dear Nick,
FDIC-insured deposits aren't at risk at financial institutions with
low bank safety ratings. That's because FDIC-insured deposits are
backed by the full faith and credit of the U.S. government. Banks
with low safety ratings often pay higher interest rates on deposits
to attract depositors, especially with CDs because savers pay a
penalty for early withdrawal.
If your bank's safety rating falls after you buy the
CD, you're not getting compensated for the change in the bank's
risk, but with an FDIC-insured deposit there's no reason to move
your money and pay the early withdrawal penalty.
As you say, when a bank fails, the failed bank's deposits
are almost always moved to a new bank, usually through a merger
of the two banks. The following is from the FDIC
Web site and discusses FDIC insurance provisions for merged
institutions:
Whenever two or more insured depository institutions
merge, their deposits continue to be separately insured for six
months from the date of the merger. Certificates of deposit assumed
by another institution continue to be separately insured until
the earliest maturity date after the end of the six-month period.
Such certificates of deposit that mature during the six-month
period and are renewed for the same term and in the same dollar
amount (either with or without accrued interest) will continue
to be separately insured until the first maturity date after the
six-month period. Such certificates of deposit that mature during
the six-month period and are renewed on any other basis, or that
are not renewed and become demand deposits, will be separately
insured only until the end of the six-month period.
Why care about bank safety ratings?
Hi Dr. Don,
I have a follow-up question to your recent column on bank safety
rankings. Given that the FDIC insurance protects deposits (within
the specified parameters), what is the additional value of looking
at the Bankrate's Safe & Sound CAEL or star ratings? Basically,
what are the risks of choosing a CD from a bank with a lower rating,
given that the bank is FDIC insured?
Thanks!
Meredith Muddle
Dear Meredith,
Savers investing in FDIC-insured deposits don't have much to worry
about when it comes to bank safety. That's because FDIC insurance
goes beyond the reserves held by the FDIC to include the full faith
and credit of the U.S. government. Since low-rated banks typically
offer higher interest rates on their insured accounts, some savers
will actually seek out these institutions to get a pickup in yield
for an insured deposit.
The bank safety rating gives you an assessment of
the bank's financial risk. According to the FDIC
Web site, "When an institution is closed by its chartering
authority, the FDIC makes payment of insured deposits to all of
the failed institution's depositors as soon as possible, usually
on the next business day after the closing."
Risk-averse investors look to bank safety ratings
as a "belt and suspenders" approach to managing risk.
Uninsured depositors look to bank safety ratings to evaluate whether
the increased yield is adequate compensation for the increased risk.
-- Posted: March 29, 2004
|
