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#581112 - 07/07/06 09:38 PM Compounding & Crediting
#12 Offline
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Joined: Jun 2005
Posts: 1,343
I know this topic has been covered a lot, but in doing a search, I couldn't find anything that really cleared up my confusion. So, I'm going to try again!

In reviewing some Truth in Savings Disclosures, I found a couple that puzzled me. One is a 60 month CD. The compounding and crediting section states: "Interest will be compounded N/A. Interest will be credited and paid by check monthly." Now, I know that the crediting section should be account specific, and that part I'm fine with. Is the compounding disclosure wrong? Technically, this CD does not compound, because a check is issued to the customer. But I also know that the compounding should be disclosed on the assumption that the customer will leave the interest in the account until maturity. So should the compounding say annually?

Second related question. On the second disclosure, the compounding line is blank, and the crediting line states that it will be added back to the principal balance at maturity. This is an 18 month CD. Is there a regulation that states that banks must compound and credit with any certain frequency (such as annually)?

Thanks in advance, sorry this was so long!
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#581113 - 07/10/06 05:06 PM Re: Compounding & Crediting
#12 Offline
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Joined: Jun 2005
Posts: 1,343
Bump...anyone?
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#581114 - 07/10/06 05:55 PM Re: Compounding & Crediting
RVFlyboy Offline
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Quote:

In reviewing some Truth in Savings Disclosures, I found a couple that puzzled me. One is a 60 month CD. The compounding and crediting section states: "Interest will be compounded N/A. Interest will be credited and paid by check monthly." Now, I know that the crediting section should be account specific, and that part I'm fine with. Is the compounding disclosure wrong? Technically, this CD does not compound, because a check is issued to the customer. But I also know that the compounding should be disclosed on the assumption that the customer will leave the interest in the account until maturity. So should the compounding say annually?



I'll take a stab at your first question. Your second one would require more research, so I'll either let someone else help with that part, or direct you to search Reg DD for references of maturity of longer than one year.

Now for your first question. If your CD requires the interest be disbursed by check, then your compounding would correctly be N/A. There is no compounding that occurs. You only assume the interest remains on deposit until maturity in calculating APY when there is the option for the interest to remain on deposit.
Quote:

Second related question. On the second disclosure, the compounding line is blank, and the crediting line states that it will be added back to the principal balance at maturity. This is an 18 month CD. Is there a regulation that states that banks must compound and credit with any certain frequency (such as annually)?



This is the part that would require more research. I know there are some provisions regarding this, but I just don't remember what they are. You'll want to check Reg DD information on maturities of more than one year.
Last edited by MagicBanker; 07/10/06 05:57 PM.
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#581115 - 07/10/06 07:43 PM Re: Compounding & Crediting
#12 Offline
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Joined: Jun 2005
Posts: 1,343
First of all, thanks for your help MagicBanker. Your posts are always very clear, and you answer questions thoroughly. I do have a follow up question though!

Quote:


Now for your first question. If your CD requires the interest be disbursed by check, then your compounding would correctly be N/A. There is no compounding that occurs. You only assume the interest remains on deposit until maturity in calculating APY when there is the option for the interest to remain on deposit.




We don't generally require the interest to be disbursed by check, it is the customer's option. The customer on this CD chose to have the interest disbursed this way. Is what you say still true?
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#581116 - 07/15/06 10:03 PM Re: Compounding & Crediting
David Dickinson Offline
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Joined: Nov 2000
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I respectfully disagree Jim. I believe compounding MUST be disclosed in this case. Here's an excerpt from our Advanced Deposit/Operations Manual on this topic:
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Compounding vs. 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.

Crediting of interest and compounding of interest are separate and distinct functions.

The greatest confusion about crediting and compounding occurs on time deposits disclosures where, at the customer’s request, interest is paid periodically to the customer either by check or by credit to another account.
Assume a time deposit on which interest is normally compounded and credited quarterly; however, at the customer’s election, the bank will transfer the earned interest to the customer’s saving account monthly. For the customer who elects that option, his or her disclosure must state monthly crediting, not quarterly crediting. A disclosure must describe the customer’s specific account, not the way an account of that type is normally processed.
The real confusion in this instance is the disclosure of compounding. The compounding frequency must be disclosed as quarterly. But, you are thinking, because interest is paid from the account monthly, it never compounds and the disclosure must be specific to the account. You are right and wrong. Compounding and annual percentage yields are disclosed on the assumption that the customer will leave the interest in the account until maturity. This is true even though you know the assumption is wrong. These are the two exceptions to the specific-to-the-account rule. Even though the customer has signed a request that the interest earned be sent to them by check monthly, the compounding frequency and APY disclosed must assume that interest is not withdrawn from the account until maturity. The only exception is when bank requires a customer to withdraw credited interest.
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