The implementation of certificate of deposit

Nowadays in banking system there is a problem of the shortage long-term liabilities. This problem can be solved by the implementation of certificate of deposit.

97% of deposits in local banks may be withdrawn by depositors without loss of interest rate during the year indicated in the study of the consulting company Ulagat Business Group.

Today retail deposits and deposits of legal entities are key source of funding. They make up two thirds of banks' liabilities. With the second wave of the global financial crisis, it is supposed that the structure will remain so for the next 5-7 years. In the case of crisis in the economy investors can start withdraw deposits. This will have very negative consequences both for the banks and for the state; in this case state will devote significant resources to support liquidity and stability of the banking system. This threatened by the situation faced by foreign banks, for example, Northern Rock - the 5th largest mortgage bank in the UK from which over 3 days about $ 4 billion was withdrawn, equivalent to 8% of the total deposit base of financial Institute. As a result, the state was obliged to provide a full guarantee for all liabilities of the bank, and the cost of its support amounted to $ 27 billion.

The analysis of the anti-crisis measures in the banking crises shows that about 70% of occasions a state is forced to allocate additional resources to support liquidity, and in 30% of occasion - a comprehensive guarantee on deposits and liabilities of banks. This issue is taken into account in the new requirements for the regulation of the banking sector Basel 3. "We plan to introduce Basel, and if it will be entered in full, then the banks will have to not only reduce the current minimum lending period exceeding one year, but also encourage customers to repay previously issued the medium and long term loans for balancing their assets and liabilities as soon as possible. Obviously, it will have negative impact on the domestic business./23/

The solution of this problem requires government program on the increase in the stability of the deposit base of commercial banks of Kazakhstan. The banks themselves cannot correct the situation in this case, as competition between banks is very high. On the other hand, the price for the mistakes of banks can be very large, because deposits are now the only source of funding. The strategy directed at the solution to presented problems lies in implementation of deposit of certificate and development

Certificate of deposit is transferable security, indicating the presence of deposits with fixed interest rates in a bank or other financial institution. There is a number of advantages of using certificate of deposit for banks and for investors. On the one hand, it eliminates the need to withdraw the money in the bank when the investor needs money, because in some cases, instead it will be possible to use certificates of deposit. If you have a certificate of deposit, then you can sell it in the market to the pension fund, insurance or Investment Company to another investor. Certificate of deposit can be used as collateral for loans or as payment for transactions.

An increase in the amount of marginal rate guarantee on deposits placed with the help of certificate of deposit can encourage the use of such tool. It is proposed to increase the amount of guarantee for deposits from 1 year to 2 years to 7.5 million tenge and increase the maximum rate of interest of KDIF by 1%, and in the case of deposit for a period greater than 2 years of age to provide assurance to increase the amount of 15 million tenge and increase interest rate by 1.5%. These measures are proposed to extend on corporate deposits.

Clearly, this will require additional capitalization of KDIF. Experts suggest that it could be a $ 3.4 billion and for these purposes they offer to use international reserves of the National Bank. "If there will be an outflow of deposits and liquidity problems, the situation could be repeated as in 2007, when in the banking system $ 10 billion was poured. It is better to increase the stability now. And besides, we can provide some kind of framework for the return of funds by banks in 5-7 years - said Marat Kairlenov.

Market participants believe that such innovations have a positive impact on the banking sector. If this project will be implemented, it will help in the development of the banking system and the economy as a whole. The economy today is in need of "long-term" money.

Let’s study the foreign experience of using certificate of deposit.

American certificate of deposit is a type of time deposit. Two general deposit categories exist with a $100000 denomination separating the groups.

Time deposits less than $100000 are most often called retail certificates of deposits or small certificates of deposit (CDs). The features of small CDs are not as standardized as large CDs although most bank market standardized instruments so that customers are not confused. Banks and customers negotiate the maturity, interest rate, and dollar magnitude of each deposit. The only stipulation is that small time deposits carry early withdrawal penalties whereby banks reduce the effective interest paid if a depositor withdraws funds prior to the stated maturity date.

Time deposits of $100000 or more are labeled jumbo certificates of deposit and are negotiable (can be bought and sold in the secondary market) with a well-established secondary market. Anyone who buys a jumbo CD or NCDs can easily sell it in the secondary market as long as the issuing bank is not suffering known problems.

Negotiable certificates of deposit (NCDs) are certificates that are issued by large commercial banks and other depository institutions as a short-term source of funds. The minimum denomination is $100000, although a $1 million denomination is more common. Nonfinancial corporations often purchase NCDs. Although NCD denominations are typically too large for individual investors, they are sometimes purchased by money market funds that have pooled individual investors’ funds. Thus, money market funds allow individuals to be indirect investors in NCDs, creating a more active NCD market. Maturities on NCDs normally range from two weeks to one year. A secondary market for NCDs exists, providing investors with some liquidity. However, institutions prefer not to have their newly issued NCDs compete with their previously issued NCDs that are being resold in the secondary market. An oversupply of NCDs for sale can force them to sell their newly issued NCDs at a lower price.

Some issuers place their NCDs directly; others use a correspondent institution that specializes in placing NCDs. Another alternative to sell NCDs to securities dealers, who in turn resell them. A portion of unusually large issues is commonly sold to NCD dealers. Normally, however, NCDs can be easily sold to investors directly at a higher price.

NCDs must offer a premium above the T-bill yield to compensate for less liquidity and safety. The premiums are generally higher during recessionary periods. The premiums also reflect the market’s perception about the safety of the financial system.

The problem of managing liquidity and interest rate risk management can be solved through the use of certificates such as Callable certificates and certificates the rate of which interest charged is tied to a change in the average market rate, or any market index (Step Up / Down, Variable rate).

A bank may issue a callable CD as a way to protect itself against changing economic conditions. With this product, the bank may offer an initial interest rate that is slightly higher than its fixed rate. However, it retains the right to "call" the CD, meaning it can take it back and issue one with a lower interest rate. The CD contract normally specifies a time frame in which the bank can call the product. Once this window passes, it must keep the CD at the initial interest rate for the duration.

Certificates of deposit such as Step Up / down and Variable rate comfortable for banks relative size of the interest to be paid will be the same, regardless of the rates in the economy. As a base of indexation average market interest rate, the inflation rate in the economy, government bond yields or market index are chosen. However, in case of Callable, and certificate with indexed interest rate, there is a risk that in the event of premature termination of the issuer or a decrease in accrued interest following the market such certificates will not be sold in the secondary market without significant losses for themselves.

There is also a Brokered certificate of deposit; they are issued by deposit brokers, that this does not prevent this kind of certificates help to solve the general problem of liquidity. The holder of such a certificate is a group of independent investors. At the same time, in view of the high risk in comparison with other certificate of deposit, interest on brokered certificate of deposit is somewhat higher and lower commissions, which makes the tool more attractive to investors.

It is important to note that almost any kind of certificate can be sold in the secondary market. For return on investment it is more profitable to realize a certificate in the market, rather than withdraw money from the bank. Banks remain long-term liabilities at a fixed price, and customers at the same time can quickly regain its contribution with minimal losses, without going to the bank. This possibility makes the client panic less dangerous for banks. As a result, interests of banks and depositors are satisfied.

In contrast to a fixed CD where the interest rate remains the same for the entire term, a bump-up CD provides the opportunity for a "bump-up" to a higher interest rate one time during the term. The potential drawbacks are that bump-up CDs usually start with a lower interest rate than fixed CDs, and there is no guarantee as to when or if interest rates will rise. It is possible that the investor will be stuck with the initially low rate throughout the term.

With most CDs, investors must agree to keep the money in the CD until its maturity date or incur substantial penalties for early withdrawals. With a liquid CD, investors have the option to withdraw money on a penalty-free basis, provided they maintain a specified minimum balance. The investor may be limited as to the number and amount of the withdrawals, and may also receive a lower interest rate than that offered by other types of CD products.

Another interesting type of certificate is Add On. This option suggests the possibility of add funds. It is very comfortable when the certificate is opened for long-term saving of funds. This again is beneficial to both banks and depositors. Customers do not need to now wait for the expiry of the old certificate to increase the amount of the deposit, and you can immediately implement the long-term investment and then simply add funds to the principal. The interest on long-term deposits is higher and money does not lie idle. For banks, such as certificates represent an increased likelihood that funds will not be withdrawn before maturity. /5, p.362/

In addition to facilities for the general population, the U.S. certificates of deposit can be beneficial even to those who wish to invest for the long term. So there are certificates of type Zero Coupon, which are issued for a period of 15-20 years and are sold at a discount. This allows customers, on the one hand, to realize their investment opportunities, and on the other hand, to give maximum flexibility to banks in terms of method of placement of these funds.

Thus, in the United States presents a set of types of certificates of deposit for all tastes, and his version will be selected for both the population willing to invest for a fixed term at a higher interest rate than time deposits, and corporations who have an opportunity to very profitable place their available cash flow. It remains to understand what prevents Kazakhstan from adopting this successful experience.

Obviously, for smooth functioning of the entire system it needs its precise regulation. In the United States, the major regulatory agencies are the Federal Reserve System and the FDIC. They set the same the requirements for all for the implementation of allocations to reserves, maintaining records of all owners, claims under certificates and all the middlemen, the general requirements for maintaining maximum transparency of the whole system and so on. In addition for creating a more comfortable environment to investors, there is CDARs (Certificate of Deposit Account Registry Service). In fact, it is an association of member banks, engaged in allocation of client resources. The association itself does not own. It only distributes. If the client wants to invest (in excess of the maximum limit of coverage) into a tool such as a certificate of deposit, coming to any bank- member of CDARs, enters into a contract with the association. The treaty is given to customer. This treaty is documentary proof of legal relations arising. Further, the bank without the participation of the client divides the entire amount into the required number of parts so that each part with interest covered by the warranty FDIC. The resulting parts are distributed to other member banks CDARs, which issue certificates of deposit, according to part. Accordingly, in case of the issue of each certificate, the issuing bank makes the necessary payments to the FDIC, as if the bank had just issued a certificate for that amount. There is no need for client to go to different banks, opening certificates to decompose a large sum at once on the same terms. In this case, all funds may be disposed of through the mediation of only one bank through which contract originally was concluded with the association. And in order to prevent situation when part of the funds are placed in those banks in which the client already has some investments in the same category of property, the customer must provide complete and accurate information about their deposits in other banks of association, if he has. Accordingly, the commission is taken by the Association for the service itself, because the client does not need to go anywhere and cares about what exactly banks issued certificates under its funds. Customer saves time, nerves and effort, workflow is simplified.

At the same FDIC has no claim against the CDARs, because in the agreement that is signed by all member banks of the Association, clearly defined all those requirements for the registration and maintenance of transparency of information systems that FDIC impose on all agents. Also, due to the passage of information on most of the certificates of deposit issued by the association, the process of collecting information on all deposits is greatly simplified for the FDIC. All this, in turn, helps to maintain a well-functioning secondary market of certificates of deposit.

This system was formed in the United States for decades. Its distinguishing feature is its flexibility, which allows banks to solve the problem of liquidity management by establishing a clear system of interest rate. At the same time, customers can choose their desired form of deposit and terminate the contract on time, pre-imagining the future and the consequences.

To sum up, we show again how a certificate of deposit of the American type can solve the problems inherent in the Kazakh banking market. Thus, the problem of lack of long-term funds by Kazakhstani banks can be solved by the fact that the American version of the certificate of deposit is issued for a longer period of time (usually 3 months to 5 years), while the secondary market of this tool really works. /23/

So, for early return on investment certificate holder can simply sell it instead of withdrawing money from the bank. This, in turn, is a solution to the problem of liquidity. Instead of mass panic withdrawals in volatile periods for the economy people can sell their certificates. The main thing is that the likelihood is high that before the repayment the money will remain in the bank, unless, of course, the possibility of an early withdrawal is not spelled out in the contract. In any case, the customer always has the right to choose, and still have the opportunity to return money quickly and relatively painless in terms of loss of a part of revenue. The presence of such a possibility could have a positive impact on the attitude of the banking system as a whole. An increase in supply of certificates of deposit in the secondary market, of course, will have its decreasing effect on the price, but it's still better than to solve the problem in the courts. However, the interest paid on certificates of deposit is higher than on conventional deposits. As a result, the both banks and depositors are happy.

As a result, banks receive long-term liabilities at a predetermined price, the population has income higher than for time deposits, return on investment and more money does not harm the banks and significantly less likely to lead to the settlement of the issue through the courts.

 

CONCLUSION

 

Carried out research of the study of the formation and strengthening the resource base of banks in a market economy has shown that the formation of the resource base, which includes not only the attraction of new customers, but also the constant change in the structure of sources of resource mobilization, is an integral part of flexible management of assets and liabilities of commercial bank. Effective liability management suggests the implementation of a competent deposit policy, which is based on maintaining the required level of diversification, providing opportunities to attract financial resources from various sources and maintenance of balance with the assets on timing, amount and interest rate.

In addition, the scope of activities of banks, defined by the object of its active operations, depends on the total amount of resources available to them, and especially the amount of borrowed funds.

Management of bank resources is a complex process of their formation and placement, which faces certain restrictions in the form of prudential standards developed by international and national supervisory authorities.

Equity capital for a commercial bank, as for any other commercial structure is the core activities that define its scope and volume of resource mobilization. In other words, the activity of commercial banks is largely determined by the size and structure of the equity.

The analysis allowed us to draw the following conclusions:

The share of capital in total equity of the bank shows the extent of forming its own capital through equity. The share capital as compared to 2010 decreased, but not by much: in the period 2010-2012, its share has decreased by 0,25%.

Analyzing the dynamics of the bank's own funds it can be concluded that the observed downward trend of total equity by reducing the share premium 0,16 % and retained earnings 55,49 %.

Other provisions in 2012 compared with 2010 have a positive trend and increased by 52,18%. However, the increase of this indicator is negative and may be associated with increased risks of banking (credit risk, interest rate risk).