The introduction of the negotiable certificate of deposit provided an effective tool to attract funds into the banking system and assured continuity in the availability of credit.
On February 20, 1961, First National City Bank of New York
What made this announcement effective in the business community was that, simultaneously, the Discount Corporation of New York
Historically, demand deposits (checking accounts) provided the bulk of the money available to banks. Under the Banking Act
One thing that bank regulations could not ensure was that investors would always place their funds in demand deposit accounts. As large corporations became more sophisticated in managing their cash, financial managers made strenuous efforts to keep demand deposits to a minimum. Any excess cash was invested in alternative short-term securities that offered an interest return. Gradually, demand deposit balances began to leave the banking system, especially when interest rates on alternative investments grew. This phenomenon is termed disintermediation.
First National City Bank also suffered from this drain on demand deposits. George S. Moore, president of FNCB, was an aggressive manager who was determined to act quickly and decisively on this issue. He solicited the advice of James Stillman Rockefeller, the bank’s chairman, in finding a creative solution. They selected Walter B. Wriston, vice president of the overseas division, to work closely with them in meeting the challenges of disintermediation.
Wriston is generally credited with resurrecting the concept of the certificate of deposit and with recognizing the pivotal nature of the negotiability feature. It was Wriston who persuaded the Discount Corporation to trade in CDs. To convince Discount Corporation to support the plan, Wriston promised to seek bank approval of monetary support for the venture in the form of a $10 million unsecured loan. Moore, Rockefeller, and the remainder of the board of directors agreed to break their own rule of not lending on an unsecured basis to a broker. The market was made. FNCB had a short-term negotiable security of its own that it could offer to its business customers as an alternative to investing in Treasury bills, corporate paper, or other money-market instruments.
Introduction of negotiable certificates of deposit proved to be a success for most banks. Chase Manhattan and Morgan Guaranty immediately followed FNCB’s lead in offering the instrument. CDs proved to be highly acceptable to investors because their quality was considered to be excellent. Competitive forces caused large banks to follow the New York City banks in offering the product. In the first three months after their introduction, about $1 billion had been invested in CDs, with about half of that total in New York City banks.
The government was very interested in the success of this new instrument. Much of the control that the Federal Reserve Board exercises over credit conditions is through money center banks. When money center banks are unable to attract deposits, the strength of these banks is reduced. As money center banks lose some of their control, the Federal Reserve’s control is also weakened. With the success of the CD, the Federal Reserve regained power.
Despite the government’s support for CDs, the Federal Reserve’s Regulation Q posed a serious threat to how effectively that instrument could counter disintermediation. Until the 1960’s, market rates stayed well under the interest rate ceilings imposed by Regulation Q. At the start of 1960, the ceiling was set at 3 percent for deposits with maturities of six months or longer. In comparison, six-month Treasury bill rates were below 3 percent. Thus, certificates with relatively long maturities were competitive. Market rates for securities of ninety days or less, however, were above Regulation Q ceilings. Short-term CDs were therefore noncompetitive. This put pressure on the Federal Reserve Board to review its rate ceiling policies. In addition, there was concern in the marketplace that, if rates continued to rise, there would be no way to issue new certificates when the first batch of CDs matured. The possibility existed that CDs could not be “rolled over” into new CDs, thus putting banks into a disintermediation scenario.
When interest rates continued to rise and deposits began flowing out of banks, the Federal Reserve Board reacted in January, 1962, to raise its ceilings. On eight different occasions between 1962 and 1980, increases in rate ceilings under Regulation Q were approved. With each increase, the negotiable CD became competitive and large volumes of funds flowed back into banks. Finally, in 1980, through the Depository Institutions Deregulation and Monetary Control Act
Corporations are large investors in CDs, but certificates are also attractive to state and local governmental units, investment-minded individuals with adequate funds, foreign governments and central banks, and a wide variety of financial institutions (primarily money market mutual funds). CDs were initially issued in $1 million denominations to dissuade customers from drawing funds out of demand deposit accounts already in the bank. With the popularity of the CD came a lowering by the marketplace of the minimum generally acceptable negotiable CD to $25,000. Many banks accepted even smaller CDs. This gave retail customers the negotiability enjoyed by institutional investors.
The negotiable certificate of deposit is a clearly different product from the traditional demand deposit to build a business around. CD purchases are normally independent events, based solely on interest rate considerations. Depositors seek out the most attractive rate at a given moment. Interest rate sensitivity becomes the prime motivator of the investor. This is a dramatic shift from the traditional relationship-based means of attracting demand deposits, by which banks tried to develop ongoing relationships and offered various services. This shift was not immediate as of February 20, 1961, the day the CDs were introduced; it emerged into full light only over the course of several years. Market funding changed bankers’ perceptions of their business and business perceptions of banks. Ultimately, the business of banking was irreversibly altered.
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Cleveland, Harold van B., and Thomas F. Huertas. Citibank: 1812-1970. Cambridge, Mass.: Harvard University Press, 1985. Devoted to the history of First National City Bank (Citibank). Emphasizes the effects of actions on the part of the bank on the nation’s economy and the banking system. Describes the background and ramifications of the decision to offer negotiable CDs to the business community. -
Heebner, A. Gilbert. “Negotiable Certificates of Deposit: The Development of a Money Market Instrument.” Bulletin, Institute of Finance, Graduate School of Business, New York University 53-54 (February, 1969): 1-96. This report analyzes in detail the first years of the negotiable CD. Written mostly in nontechnical language and clearly describes the nature of the security and its importance to banking. -
Lash, Nicholas A. Banking Laws and Regulations: An Economic Perspective. Englewood Cliffs, N.J.: Prentice Hall, 1987. A comprehensive but nontechnical review of the major laws and regulations affecting the banking systems. Valuable to readers who want to follow the influence of regulation on the development of the CD. Fully describes the evolution and termination of Regulation Q. -
Nadler, Paul S. “Time Deposits and Debentures: The New Sources of Bank Funds.” Bulletin, Institute of Finance, Graduate School of Business, New York University 30 (July, 1964): 1-32. Analyzes the pressure placed on commercial banks to replace demand deposits with certificates of deposit. Gives insight into the forces that culminated in acceptance of the product. -
Rose, Peter S. Money and Capital Markets. Homewood, Ill.: Richard D. Irwin, 1992. A financial markets textbook. Includes in Chapter 15 a comprehensive discussion of the negotiable CD. Describes the basic characteristics of the instrument, its terms, its growth, investors in the security, and creative innovations in the product. -
Zweig, Phillip L. Wriston: Walter Wriston, Citibank and the Rise and Fall of American Financial Supremacy. New York: Crown, 1995. A 952-page biography of Walter Wriston, the Citibank banker responsible for resurrecting the certificate of deposit and for the idea of the importance of CD negotiability.
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