The competition is not always rational. Setting rates based solely on the competitions’ irrational behavior is not a prudent approach. However, knowing what your competitors are paying is very helpful in deciding to set the rates on the low or high end of your “rational” analysis.
Considerations for setting rates.
- A financial institution should pay slightly more than the treasury rate. An investment in a treasury bill or bond is arguably risk free. A CD also is basically risk free but technically slightly more risky than a treasury bill/bond. A financial institution should generally pay 5-25 basis points more than the treasury rates.
- Financial institutions with high loan demand and in need of funds should consider paying a slightly higher rate than the competition.
- Since most credit unions can borrow from the Federal Home Loan Bank (FHLB) it doesn’t make a lot of sense to pay substantially more on CDs than rates they can borrow. Of course, generally, paying your members a good rate is preferable to paying the FHLB.
- Obviously, the competitions’ rates are a necessary consideration. Being on the high side will bring in deposits. Being on the low side will chase money away.