Market microstructure: an analysis of bank-specific factors in the retail CD pricing

Economic theory suggests that in a competitive market, prices tend to converge. This article examines the prices of small-denomination (<$100,000) certificates of deposit (CDs) offered by commercial banks in 50 major US cities. Owing to information provided by internet websites, the markets for CDs have become increasingly competitive in recent years. Nevertheless, we found large variations in CD rates and yields among the banks in major US cities, and across cities. To date, research regarding small denomination retail CDs has focused on the relationship between the rates and market-common or macroeconomic factors. Our study is unique in that the primary focus is to identify bank-specific variables explaining significant variations in retail CD yields, thereby enabling more effective revenue management in a broad sense. We find very strong evidence that asset size, the cost of funding earning assets, and the ratio of non-interest-bearing deposits to total deposits are the factors characterising those differences. Taken together, it suggests that the large banks with higher cost of funding and lower non-interest-bearing deposit ratio would be willing to pay the higher prices on their retail CDs, indicating that liquidity would play a prime role in pricing retail CDs.