Types of Deposits Offered by Banks and Other Depository Institutions
The number and range of deposit services offered by depository institutions are impressive
indeed and often confusing for customers. Like a Baskin-Robbins ice cream store, deposit plans
designed to attract customer funds today come in 31 flavors and more, each plan having features
intended to closely match business and household needs for saving money and making payments
for goods and services.
Transaction (Payments or Demand) Deposits
One of the oldest services offered by depository institutions has centered on making payments on
behalf of customers. This transaction, or demand, deposit service requires financial-service
providers to honor immediately any withdrawals made either in person by the customer or by a
third party designated by the customer to be the recipient of funds with- drawn. Transaction
deposits include regular noninterest-bearing demand deposits that do not earn an explicit interest
payment but provide the customer with payment services, safe- keeping of funds, and
recordkeeping for any transactions carried out by check, card, or via an electronic network, and
interest-bearing demand deposits that provide all the foregoing services and pay interest to the
depositor as well.
Noninterest-Bearing Transaction Deposits
Interest payments have been prohibited on regular checking accounts in the United States since
passage of the Glass-Steagall Act of 1933. Congress feared at the time that paying interest on
immediately withdrawable deposits endangered bank safety- a proposition that researchers have
subsequently found to have little support. However, demand (transaction) deposits are among the
most volatile and least predictable of a depository institution's sources of funds, with the shortest
potential maturity, because they can he withdrawn without prior notice. Most noninterest-bearing
demand deposits are held by business firms.
Interest-Bearing Transaction Deposits
Many consumers today have moved their funds into other types of transaction deposits that pay
at least some interest. Beginning in New England during the 1970s, hybrid checking-savings
deposits began to appear in the form of negotiable order of withdrawal (NOW) accounts.
NOWs are interest-bearing savings deposits that give the offering depository institution the right
to insist on prior notice before the customer withdraws funds. Because this notice requirement is
rarely exercised, the NOW can be used just like a checking (transaction) account to pay for
purchases of goods and services. NOWs were permitted nationwide beginning in 1981 as a result
of passage of the Depository Institutions Deregulation Act of 1980. However, they can be held
only by individuals and nonprofit institutions. When NOWs became legal nationwide, the U.S.
Congress also sanctioned the offering of automatic transfers (ATS), which permit the customer to
preauthorize a depository institution to move funds from a savings account to a transaction
account in order to cover overdrafts. The net effect was to pay interest on transaction balances
roughly equal to the interest earned on a savings account.
Two other important interest-bearing transaction accounts were created in the United States in
1982 with passage of the Garn-St Germain Depository Institutions Act. Banks and thrift
institutions could offer deposits competitive with the share accounts offered by money market
funds that carried higher, unregulated interest rates and were backed by a pool of high-quality
securities. The result was the appearance of money market deposit accounts (MMDAs) and
Super NOWS (SNOWs), offering flexible money marker interest rates but accessible via check
or preauthorized draft to pay for goods and services.
MMDAs are short-maturity deposits that may have a term of only a few days, weeks, or months,
and the offering institution can pay any interest rate that is competitive enough to attract and hold
the customer's deposit. Up to six preauthorized drafts per month are allowed, but only three
withdrawals may be made by writing checks. There is no limit to the personal withdrawals the
customer may make (though service providers reserve the right to sec maximum amounts and
frequencies for personal withdrawals). Unlike NOWS, MMDAs can be held by businesses as
well as individuals.
Super NOWs were authorized at about the same time as MMDAs, but they may be held only by
individuals and nonprofit institutions. The number of checks the depositor may write is not
limited by regulation. However, offering institutions post lower yields on SNOWs than on
MMDAs because the former can be drafted more frequently by customers. Incidentally, federal
regulatory authorities classify MMDAs today not as transaction (payments) deposits, but as
savings deposits. They are included in this section on transaction accounts because they carry
check-writing privileges.
Nontransaction (Savings or Thrift) Deposits
Savings deposits, or thrift deposits, are designed to attract funds from customers who wish to set
aside money in anticipation of future expenditures or financial emergencies. These deposits
generally pay significantly higher interest rates than transaction deposits do. While their interest
cost is higher, thrift deposits are generally less costly to process and manage.
Just as depository institutions for decades offered only one basic transaction deposit- the regular
checking account-so it was with savings plans. Passbook savings deposits were sold to
household customers in small denominations (frequently a passbook deposit could be opened for
as little as $5), and withdrawal privileges were unlimited. While legally a depository institution
could insist on receiving prior notice of a planned withdrawal from a passbook savings deposit,
few institutions have insisted on this technicality because of the low interest rates paid on these
accounts and because passbook deposits tend to be stable anyway, with liccle sensitivity to
changes in interest rates. Individuals, non- profit organizations, and governments can hold
savings deposits, as can business firms, but in the United States businesses cannot place more
than $150,000 in such a deposit.
Some institutions offer statement savings deposits, evidenced only by computer entry. The
customer can get monthly printouts showing deposits, withdrawals, interest earned, and the
balance in the account. Many depository institutions, however, still offer the more traditional
passbook savings deposit. where the customer is given a booklet showing the account's balance,
interest earnings, deposits, and withdrawals, as well as the rules that bind both depository
institution and depositor.
For many years, wealthier individuals and businesses have been offered time deposits, which
carry fixed maturity dates (usually covering 30, 60, 90, 180 or 360 days) with fixed interest rates.
More recently, time deposits have been issued with interest rates adjusted periodically (such as
every 90 days, known as a leg or roll period). Time deposits must carry a minimum maturity of
seven days and cannot be withdrawn before that.
Time deposits come in a wide variety of types and terms. However, the most popular of all time
deposits are CDs-certificates of deposit. CDs may be issued in negotiable form-the $100,000plus instruments purchased principally by corporations and wealthy individuals that may be
bought and sold any number of times prior to reaching their maturity—or in nonnegotiable formsmaller denomination accounts that cannot be traded prior to maturity and are usually acquired
by individuals. Innovation has entered the CD marketplace recently with the development of
bump-up CDs (allowing a depositor to switch to a higher interest rate if market interest rates
rise); step-up CDs (permitting periodic upward adjustments in promised interest rates); and
liquid CDs (allowing the depositor to withdraw some of his or her funds without a withdrawal
penalty).
In 1981, with passage of the Economic Recovery Tax Act, Congress opened the door to yet
another deposit instrument-retirement savings accounts. Wage earners and salaried individuals
were granted the right to make limited contributions each year, tax free, to an individual
retirement account (IRA), offered by depository institutions, brokerage firms, insurance
companies, and mutual funds, or by employers with qualified pension or profit-sharing plans.
There was ample precedent for the creation of IRAs; in 1962, Congress authorized financial
institutions to sell Keogh plan retirement deposits, available to self-employed persons.
Unfortunately for depository institutions and their customers interested in IRAs, the Tax Reform
Act of 1986 restricted the tax deductibility of additions to an IRA account, which reduced their
growth rate somewhat, though Keogh deposits retained full tax benefits.
Then, in August 1997 the U.S. Congress, in an effort to encourage saving for retirement,
purchases of new homes, and childrens' education, modified the rules for IRA accounts, allowing
individuals with higher incomes to make annual tax-deductible contributions to their retirement
accounts and families to set up new education savings accounts that could grow tax free until
needed to cover college tuition and other qualified educational expenses. Finally, the Tax Relief
Act of 1997 created the Roth IRA, which allows individuals to make nontax-deductible
contributions to a savings fund that can grow tax free and also pay no tax on their investment
earnings when withdrawn.
Today depository institutions in the United States hold about a quarter of all IRA and Keogh
retirement accounts outstanding, ranking second only to mutual funds. The great appeal for the
managers of depository institutions is the high degree of stability of IRA and Keogh deposits-financial managers can generally rely on having these funds around for several years. Moreover,
many IRAs and Keoghs carry fixed interest rates-an advantage if market interest rates are rising
allowing depository institutions to earn higher returns on their loans and investments that more
than cover the interest costs associated with IRAs and Keoghs. (These retirement accounts were
made more attractive to the public in 2006 when the U.S. Congress voted to increase FDIC
insurance coverage to $250,000 for qualified retirement-plan deposits.)