The Lose-Lose CD Penalty That’s Ruining Deposit Profitability

One man’s trash is another man’s treasure. That’s usually how regulators look at “junk fees,” banks benefit, and consumers are “harmed.” But nearly everyone is neglecting the real junk fee that’s still charged by institutions: Penalties for early withdrawal on certificates of deposit.

How are CD penalties a junk fee?

Traditional CD penalties are actually even worse than the common targets for the term “junk” because they are often not beneficial to anyone – not the consumer, and not even to the banks and credit unions that charge them. They cost banks serious sums in profitability, often penalizing depositors for a withdrawal when it helps the bank.

Need to Know:

• Banking’s worst junk fees are traditional penalties for early withdrawal on certificates of deposit because they are bad for both banks and consumers.
• How are traditional penalties bad for banks? They actually make the least expensive –and more valuable – CDs vulnerable, and the most expensive CDs locked-in.
• Consumers also avoid CDs because of their penalty, which punishes them even when they withdraw funds from expense deposits that the bank can replace at a lower cost.
• Institutions don’t need no-penalty CDs; they need CDs structured with a rational, market-value-driven early withdrawal process.

Here’s why CD penalties ought to be the first fee on the “junk” list. They’re not fees that consumers hate, and banking loves. They’re a fee assessed for the worst reason: Because it’s always been done that way.

Here’s why banking can eliminate the old CD penalty without losing the benefits it was intended to provide, and why it could make the certificate portfolio considerably less expensive.

Not Tracked by CEOs

If you ask most bank executives, even presidents and CEOs, they don’t know how much their institution made on CD penalties last year. It’s not a revenue stream they’re keen to follow. Who is keenly aware of penalties, though? You’d be right if you guessed depositors.

Everyone knows putting money into a CD means locking it up, and the key feature that creates that lock is the penalty for early withdrawal. So, to entice depositors to enter a contractual structure, institutions pay high rates (usually at the top of their price offering) on CDs. The high rate is the sugar on the medicine for the depositor, who is giving up flexibility, and the penalty is supposed to protect the bank in return for paying a high price.

That would be all fine and good, except for one thing: No one ends up preferring a CD. Banking executives tend to disfavor them because of their cost, and depositors tend to choose more liquid alternatives if they can get a comparable rate. To quote one industry observer, “CDs just kind of [stink].” You can guess the word I edited out there.

Before executives conclude “I am ok with people not wanting CDs,” remember that no institution can fund itself entirely with deposits that can leave at any moment. Institutions need deposits contracted to stay and need CDs to fund their balance sheet. This isn’t about liking or disliking; it’s about figuring out why CDs “stink” and whether they could add more value.

So, is it objectively true that the old CD penalty is not beneficial to banks?

Why the Traditional CD Penalty is Junk, Part 1

The traditional CD penalty – which calculates an early withdrawal fee based on the CD’s interest rate – destroys deposit portfolio profitability, rather than protecting it. Institutions can see this at both the product design and balance sheet levels.

At the product design level, consider a depositor with 12 months remaining on a CD at 5.2% with a current balance of $100,000. If the CD matures, the institution will incur $5,200 in interest expense. Now, suppose the depositor needs the funds, and wholesale rates are now at 4.2%. If the depositor withdraws early, the total possible benefit to an institution is approximately $1,000 in saved interest expense.

Yet, many banks and credit unions assess a penalty in the above situation. Or, the penalty threatened by the CD’s disclosures disincentivizes an action that would save the bank over 19% of its interest expense.

Look at the funding portfolio as a whole, and the damage gets worse.

I wrote above that “executives tend to disfavor CDs for their cost.” That’s not completely true. They actually love certain CDs: The ones locked in at 1% or 2%. Yet, these are the least protected by the traditional penalty. Ten financial institutions studied in 2025 had $4.04 billion in certificates. And, they had some $112 million in CDs at rates below 1%. When deposit rates rose, depositors could eat the penalty and get a new CD at a higher rate for the same term, leaving the bank to replace the funds at higher rates.

That same portfolio has another $530 million in CDs with rates below 3% across all terms. At the time of the study, depositors could eat the penalty on these, keep their maturity date with another bank, and earn more interest, though the economics were less extreme.

The bank paid CD rates to get people to accept a penalty structure (one based on interest rate) that didn’t actually protect their best CDs when rates changed materially.