John said it best with this statement: "The customer's withdrawals don't change the APY." Why? Because the TISA rules state the APY ASSUMES interest remains on deposit until maturity. IOW, crediting has nothing to do with APY calculations.
Here's an article I wrote on this very topic in 1993. I hope this helps clarify this issue for you.
Compounding and Crediting:
Compounding occurs when the interest earned on an account begins to earn interest itself. The frequency of compounding is the frequency in which interest that has been earned is added to the balance of the account (principal). Whether the earned interest is or is not available for withdrawal is of no consequence to the compounding frequency.
Crediting is the process of making interest that has been earned available for withdrawal. The frequency of crediting is the frequency with which that process occurs. Whether or not interest begins to be earned on the interest that becomes available for withdrawal is not a factor.
It is important to remember that compounding and crediting of interest are separate and distinct functions. One does not depend on the other. Institutions are free to determine the frequency at which they will compound and credit interest to a deposit account.
Generally, compounding is based on the institution’s policy while crediting is specific to the individual account (customer specifications).
Both the compounding and crediting frequency must be disclosed in the initial account disclosure. Generally this disclosure is fairly simple and straightforward. For example, an institution might compound and credit monthly on a checking account while it might be done quarterly for a savings account.
The greatest confusion about the disclosure of the compounding and crediting frequency occurs with time deposits (for example, CDs). On these accounts it is quite common for the consumer to request that interest be paid to them either by check or transferred to another account rather than being added to the principal balance. Consider the following:
Interest Paid to Account Principal
Compounding – Quarterly
Crediting – Quarterly
Interest Paid by Check
Compounding – Quarterly
Crediting – Monthly
As stated before, the compounding frequency does not change since this is determined by the institution’s policy. However, the crediting frequency is specific to the account. Thus, the crediting frequency must be disclosed differently, to show what is actually occurring on the account.
This doesn’t end the confusion, however. Since the interest is being paid monthly, many institutions assume the compounding frequency should also be disclosed as monthly based on the fact that interest will never really compound. This is both a right and wrong assumption. Correct in the real world, but wrong according to Regulation DD disclosure requirements.
With respect to time accounts, the Annual Percentage Yield calculation assumes that interest remains on deposit until maturity. This fact is required to be disclosed in the initial disclosure. Since the Annual Percentage Yield calculation is dependent on the compounding frequency, the compounding frequency and APY disclosed must assume that interest is not withdrawn from the account until maturity. The only exception to this rule is when an institution requires a consumer to withdraw credited interest.
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